Financial Report at December 31, 2010 Volume 1

Action, 1 2006-2009 ﬁgures restated excluding Pirelli RE and Pirelli & C. S.p.A. Consolidated Figures Pirelli Broadband Solutions (discontinued operations) Pirelli Tyre

SALES1 EBIT1; EBIT MARGIN1 SALES 4,772 EBIT; EBIT MARGIN VOLUME 1 € / mln 4,848 € / mln € / mln € / mln 4,162 4,100 3,950 3,993 8.4% 4,239 4,171 9.5% 4,010 4,067 7.8% 7.4% 8.7% 8.6% 408 7.7% 453 6.1% 330 358 298 342 250 309 2.6% 3.7%

111 2006 2007 2008 2009 2010 151 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 ∆% yoy 8.7% 5.4% -1.5% -2.6% 19.5% Volume 3.9% 1.8% -6.0% -5.8% 7.3% ∆% ∆% Price/Mix 3.1% 4.7% 7.3% 4.2% 8.9% yoy +5.7% -1.6% -2.5% +19.2% yoy +10.7% -66.5% +126.0% +63.3% Revenues organic7.0% 6.5% 1.3% -1.6% 16.2% 2006 2007 2008 2009 2010

ATTRIBUTABLE NET INCOME DIVIDEND PER SHARE 4 R&D; R&D/Sales R&D expenses CAPEX; CAPEX / Sales Capex € / mln € / cent € / mln € / mln 165 R&D/Sales Capex / Sales 80,1 DPS Ord 44,6 DPS Sav 8.4%

23 22 3.7% 3.6% 3.5% 3.3% 7.0% 402 3.1% 6.3% 2006 2007 2008 2009 2010 5.7% 5.4% 22,9 285 262 17,6 16,0 16,5 224 217

147 148 145 146 No No 133 distribution distribution (348) 2 Olimpia in discontinued operations; excluding gain from 2006 2007 2008 2009 2010 sale of the 38.9% stake in Pirelli Tyre and the investment 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 Dividends 93 81 81 in Capitalia €/mln 3 Facility management and Photonics in discontinued Op; (1,167) including TI devaluation Pay out on Parent 93% 72% 93% SALES BY GEOGRAPHY 19 INDUSTRIAL PLANTS IN 11 COUNTRIES company net income INCOME BEF. DISCONTINUED OPERATION 1 1. USA 3. Germany 4. Italy 5% 4 DPS 2006-2009 restated following P&C shares reverse stock split with the ratio 6% 6% 6% 6% Rome Car Breuberg Car/Moto Bollate (MI) Car 1312 147 -2103 78 228 of 1 new share per each 11 old shares Asia/Paciﬁc Merzig Steelcord Settimo Torinese Car/Truck 2. GB Figline Valdarno Steelcord 10% 10% 10% 10% 10% Burton Car 5. Romania NET DEBT GROSS DEBT 2010 YE Carlisle Car Slatina Car/Steelcord € / mln € / mln MEA

1,147 123.3 1 2 3 4 5 Committed 25% Line 27% 1,980 104 Central & 31% Drawdown South America 34% 34% 1,028 380 49 92 529 456 380 NAFTA 9% 2006 2007 2008 2009 2010 146.7 9% 6 8% 7 (302) Other european 8% 10% GEARING 11 8 New 5 year countries 10 42% n.m. 43% 21% 22% bond 9 Italy NET CASH FLOWS FROM 380 40% 38% Other 767 36% 33% OPERATING ACTIVITIES Borrowings 31% € / mln 628 11. Venezuel 6. Turkey 554 532 Guacara Car Izmit Car/Truck Steelcord 473 252 10. Brazil 11% 10% Campinas Car 7. China 9% 9% 9% Feira de Santana Car/Truck Yanzhou Car/Truck 2010 2011 2012 2013 2014 2015 2016 Santo Andrè Truck/Agro 76 2006 2007 2008 2009 2010 Gravatai Moto/Truck 9. Argentina 8. Egypt & beyond Sumarè Steelcord Merlo Car Alexandria Truck Consumer 69% 69% 68% 71% 70% 2006 2007 2008 2009 2010 Gross Debt 2010 22.0% 12.8% 8.0% 4.3% 9.1% 43.8% Industrial 31% 31% 32% 29% 30% Committed Year end Capacity (mln pz) 2010 % in low cost countries – 2010 % ON SALES OE 21% 24% 24% 23% 25% Line not Consumer 56.0 71% 9.8% 11.6% 1.6% 13.1% 13.0% Drawdown 1,200 mln € maturing in 2015 Replacement 79% 76% 76% 77% 75% Industrial 5.8 93% 1 2006-2009 ﬁgures restated excluding Pirelli RE and Pirelli & C. S.p.A. Consolidated Figures Pirelli Broadband Solutions (discontinued operations) Pirelli Tyre

ATTRIBUTABLE NET INCOME DIVIDEND PER SHARE 4 R&D; R&D/Sales R&D expenses CAPEX; CAPEX / Sales Capex € / mln € / cent € / mln € / mln 165 R&D/Sales Capex / Sales 80,1 DPS Ord 44,6 DPS Sav 8.4%

23 22 3.7% 3.6% 3.5% 3.3% 7.0% 402 3.1% 6.3% 2006 2007 2008 2009 2010 5.7% 5.4% 22,9 285 262 17,6 16,0 16,5 224 217

Many of the images used were produced by the students of naba (Nuova Accademia di Belle Arti Milano) at Pirelli’s request.

Graphic design Leftloft, Milan

Printing Arti Grafiche Mario Bazzi S.p.A.

Printed on Arctic Paper Munken Lynx

The results’ documentation can be found online at www.pirelli.com Pirelli & C. S.p.A. — Milan Annual Financial Report at December 31, 2010 Volume 1

General information 5

CALL OF GENERAL MEETING

The ordinary shareholders of Pirelli & C. Società per Azioni are called to the Ordinary and Extraordinary Sharehold- ers’ Meeting in Milan, Viale Sarca n. 214, − at 10:30 a.m. on Wednesday, April 20, 2011 on the first call; − at 10:30 a.m. on Thursday, April 21, 2011 on the second call, to discuss and resolve on the following

AGENDA

Ordinary part 1. Annual Report at December 31, 2010. Relevant and consequent resolutions. 2. Election of the Board of Directors: - determination of the number of seats on the Board of Directors; - determination of the term of the Board of Directors; - election of the Directors; - determination of the annual compensation of members of the Board of Directors; 3. Discussion of the General Policy for Group Remuneration.

Extraordinary part 1. Amendment of Articles 5 (Share Capital), 7 and 8 (General Meeting), 10 and 11 (Management), 16 (Board of Directors) of the Bylaws. Relevant and consequent resolutions. 2. Voluntary reduction of Share Capital by Euro 32,498,345.12, pursuant to Section 2445 Italian Civil Code, to be charged to Net Equity; consequent amendments to Article 5 of the Bylaws. Relevant and consequent resolutions. 6 Annual Financial Report at December 31, 2010 Volume 1

COntents

Annual financial report at december 31, 2010 Volume 1

General information 5

Call of General Meeting 5 Summary of selected consolidated financial data 11 Pirelli & C. S.p.A. Board of Directors 9 Chairman’s letter 12 Structure of Pirelli Group at December 31, 2010 10

Directors’ report* 32

Directors’ report on operations 33 Significant events during the year 35

The Group 42

Selected economic and financial data 43 1. Strategic risks 54 Research and development activities 48 2. Cross business risks 56 Significant events subsequent to the end of the year 53 Business outlook 57 Risks and uncertainties 53

Pirelli Tyre 58

Selected economic and financial data 59 Industrial business 67 Consumer business 64

Other businesses 68

Pirelli Eco Technology 69 PZero S.r.l. 71 Pirelli Ambiente 71

Pirelli & C. S.p.A: Highlights 72

Other information 76

Equity interests held by directors, statutory auditors, Information on ownership structure 77 general managers and key managers 77 Security policy document 77 Stock option plans 77 Foreign subsidiaries not in the european union 78

Resolutions 80

Allocation of net result Appointment of the Board of Directors 82 and Coverage for the IAS Transition Reserve 81 Remuneration Group Report 84 General information 7

Consolidated financial statements 90

1. General information 96 24. Borrowings from banks and other financial institutions 143 2. Basis of presentation 96 25. Trade payables 146 3. Accounting policies 97 26. Other payables 146 4. Financial risk management policies 109 27. Derivative financial instruments 147 5. Capital management policies 115 28. Commitments and contingencies 147 6. Estimates and assumptions 116 29. Revenue from sales and services 148 7. Operating segments 117 30. Other income 149 8. Property, plant and equipment 120 31. Personnel expense 149 9. Intangible assets 123 32. Amortisation, depreciation and impairment 149 10. Investments in associates and joint ventures 125 33. Other costs 150 11. Other financial assets 127 34. Net income (loss) from equity investments 150 12. Deferred tax assets and liabilities 129 35. Financial income 152 13. Trade receivables 130 36. Financial expenses 152 14. Other receivables 131 37. Income taxes 153 15. Tax receivables 132 38. Net income (loss) from discontinued operations 154 16. Inventories 132 39. Earnings/(losses) per share 155 17. Securities held for trading 132 40. Dividends per share 156 18. Cash and cash equivalents 133 41. Hyperinflation 156 19. Equity 133 42. Related party transactions 157 20. Stock option plans 135 43. Significant events subsequent to the end of the year 159 21. Tax payables 136 44. Other information 159 22. Provisions for liabilities and charges 136 Certification of the consolidated financial statements 168 23. Employee benefit obligations 137 Independent auditors’ report 170

Extraordinary part 172

Explanatory Report by the Directors and Proposals of Resolution 173 Resolves 177 Report on Corporate Governance and the structure of share ownership** Volume 2 Sustainability Report 2010 Volume 3

* The Annual Report on Corporate Governance and Ownership Structure included in Volume 2 is a specific, integral section of the Directors’ Report on Operations. ** This volume is a specific, integral section of the Directors’ Report on Operations.

General information 9

PIRELLI & C. S.P.A. BOARD OF DIRECTORS1

Chairman Marco Tronchetti Provera

Deputy Chairman Alberto Pirelli Deputy Chairman Vittorio Malacalza

Directors Carlo Acutis * Carlo Angelici * o Cristiano Antonelli * o Gilberto Benetton Alberto Bombassei * ^ Franco Bruni * o Luigi Campiglio * Enrico Tommaso Cucchiani Giulia Maria Ligresti Massimo Moratti Renato Pagliaro Umberto Paolucci * ^ Giovanni Perissinotto Giampiero Pesenti * ^ Luigi Roth * o Carlo Secchi * o

* Independent director o Member of the Internal Control, Risks and Corporate Governance Committee ^ Member of the Remuneration Committee

Secretary to the Board Anna Chiara Svelto

Board of Statutory Auditors 2 Chairman Enrico Laghi Statutory Auditors Paolo Gualtieri Paolo Domenico Sfameni Franco Ghiringhelli Alternate Auditors Luigi Guerra

General Manager Tyre General Management Francesco Gori

Independent Auditor 3 Reconta Ernst & Young S.p.A.

Corporate Financial Reporting Manager 4 Francesco Tanzi

1 Appointment: April 29, 2008. Expiry: Shareholders’ Meeting called to approve the financial statements at December 31, 2010. Vittorio Malacalza was co-opted by the Board of Directors on July 29, 2010 to replace Carlo Alessandro Puri Negri, who resigned on the same day. Posts conferred by the Board of Directors to Marco Tronchetti Provera and Alberto Pirelli on April 29, 2008 and Vittorio Malacalza on October 14, 2010. 2 Appointment: April 21, 2009. Expiry: Shareholders’ Meeting called to approve the financial statements at December 31, 2011. 3 Post conferred by the Shareholders’ Meeting held on April 29, 2008. 4 Appointment: post conferred by the Board of Directors meeting held on September 16, 2009. Expiry: Shareholders’ Meeting called to approve the financial statements at December 31, 2010. 10 Annual Financial Report at December 31, 2010 Volume 1

STRUCTURE OF PIRELLI GROUP AT DECEMBER 31, 2010 PIRELLI CORPORATE PIRELLI & C. S.p.A.1 STRUCTURE

PIRELLI PIRELLI & C. Eco PIRELLI & C. PZERO Tyre S.p.A. Technology S.p.A. Ambiente S.p.A. S.r.l 100% 51% 51% 100% 1 Pirelli businesses are supported by Pirelli Labs (100% Pirelli & C), a centre of technological excellence and engine of innovation

% on total ~98% ~1.3% sales SHAREHOLDERS

STRUCTURE Free Float Camfin1 2010 47.9% 5.9%

Shareholders Agreement 1 Stake not conferred to the Shareholders Agreement. Camfin totally owns 26.2% of ordinary share capital 46.2%

Free Float: 47.9%2 Shareholders Agreement: 46.2% Institutional Investors 29.0% — Camfin S.p.A. 20.32% — UK 6.3% — Mediobanca S.p.A. 4.61% — Italy 7.3% — Edizione S.r.l. 4.61% — Continental Europe 8,6% — Fondiaria SAI S.p.A. 4.42% — US & Canada 5.8% — Allianz S.p.A. 4.41% — Rest of the World 1.0% — Ass. Generali S.p.A. 4.41% Retail 16.8% — Intesa Sanpaolo S.p.A. 1.62% Other Shareholders 2.1% — Massimo Moratti 1.19% — Sinpar S.p.A. 0.63% 2 Source: Sodali (Shareholder ID August 2010) and Shareholders Register

MARKET 2010YE 2009YE 2008YE Pirelli Ordinary CAPITALIZATION (Reuters: PECI.MI; Bloomberg: PC IM) 2,940.6 2,097.9 1,284.4 (€mln)3 Pirelli Saving (Reuters: PECIn.MI; Bloomberg: PCP IM) 70.1 56.9 33.7

3 Based on December average price Total 3,010.7 2,154.8 1,318.1 General information 11

SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA

(in milions of euro) 2010 20091 2008 2007 2006 (historical)

Net sales 4.848 4.067 4.660 6.076 4.841 Net sales (excluding DGAG * - PRE) 4.660 4.780 4.841 Gross operating profit 629 453 252 573 614 % of net sales 13.0% 11.1% 5.4% 9.4% 12.7% Operating income 408 250 43 364 401 % of net sales - ROS 8.4% 6.1% 0.9% 6.0% 8.3% Net income (loss) from continuing operations 228 77 Net income (loss) from discontinued operations (224) (100) Total net income (loss) 4 (23) (413) 324 (1.049) Net income attributable to owners of Pirelli & C. S.p.A. 22 23 (348) 165 (1.167) Total net earnings (losses) per share attributable to the owners of Pirelli & C. S.p.A. (in euro) 0.044 0.0472 (0.065) 0.031 (0.217)

Non-current assets 3.164 3.596 3.665 3.815 6.924 Net working capital 117 222 418 298 463 Net invested capital 3.281 3.818 4.083 4.113 7.387 Equity 2.028 2.495 2.374 3.804 4.687 Provisions 797 795 681 611 720 Net financial (liquidity)/debt position 456 529 1.028 (302) 1.980 Equity attributable to the owners of Pirelli & C. S.p.A. 1.991 2.175 2.172 2.980 3.880 Equity per share attributable to the owners of Pirelli & C. S.p.A. (in euro) (*) 4.08 4.462 0.40 0.56 0.72

Operating income/Net invested capital ** - ROI 11.49% 6.32% 1.05% 6.33% 5.36% Net income (loss)/Equity ** - ROE 0.19% (0.93%) (13.35%) 7.63% (20.37%)

Net cash flows provided by/(used for) operating activities 628 532 76 554 473

Research and development expenses 150 137 156 173 171 % of net sales 3.1% 3.4% 3.3% 2.8% 3.5%

Amortization and depreciation 217 198 199 214 201 Capital expenditure 433 225 311 287 255 Capital expenditure/depreciations 2.00 1.14 1.56 1.34 1.27

Net financial position/Equity - Gearing 0.22 0.21 0.43 n.s. 0.42

Sales * per employee (in thousands of euro) 160 138 148 155 172

Ordinary shares of Pirelli & C. S.p.A. (no. millions) 475.7 5,233.1 5,233.1 5,233.1 5,233.1 Savings shares of Pirelli & C. S.p.A. (no. millions) 12.3 134.8 134.8 134.8 134.8 Total shares of Pirelli & C. S.p.A. (no. millions) (°) 488.03 5,367.9 5,367.9 5,367.9 5,367.9 Treasury ordinary shares (no. millions) 0.4 3.9 3.9 2.6 2.6 Savings ordinary shares (no. millions) 0.4 4.5 4.5 - -

Employees (number at end of period) 29,573 29,570 31,056 30,823 28,617 of which temporary workers 2,426 2,245 2,913 3,642 3,479

1 Comparative income statement figures for 2009 related to Pirelli RE (now Prelios) and Pirelli Broadband Solutions segments. discontinued in 2010. have been reclassified to “net income (loss) from discontinued operations” 2 2009 per share figures has been reclassified on a comparable basis after the reverse stock split pursuant the Shareholders’ Meeting resolution of July 15. 2010 3 Reverse stock split in execution of the resolution passed by the Shareholder’s Meeting on July 15. 2011 (ratio 1 to 11) * Excluding net sales for deconsolidation DGAG real estate assets ** Average amounts 12 Annual Financial Report at December 31, 2010 Volume 1

Dear shareholders,

The year 2010 was an important one for Pirelli. The targets set in the 2009-2011 industrial plan were reached ahead of schedule and exceeded, both in terms of strategic position- ing and in terms of economic results.

First of all, strategy. In line with our goal of focusing Pirel- 3-year period 2011-2013, based on a vision of strategy li on the industrial activities of Pirelli Tyre, 2010 saw the and scenarios that extends to 2015. It is a plan which completion of the process of separation of the real estate will see Pirelli focused on satisfying the growing demand activities of Pirelli Re and the disposal of non-strategic from the Premium segment, where our company already activities, with the consequent transformation of Pirelli excels at the global level, and ready to seize opportuni- into a ‘pure Tyre company’. This transformation enables ties for geographical diversification linked to the growth a more immediate reading of our industrial strategy and of rapidly developing economies and, given the constant our economic data by the market. In 2010, these data increase in the cost of raw materials, also committed to benefited from the worldwide recovery in demand for research and the development of agreements in the area tyres and our ability to adapt strategies to the economic of materials as alternatives and complements to the use climate, as well as our continued attention to costs, con- of natural rubber. stant commitment to greater efficiency, financial rigour, and product and process innovation. The business’s good The strengthening of our financial and asset structure, performance and the effectiveness of operations’ manage- achieved with the cash flow generated by Pirelli Tyre and ment allowed us to conclude 2010 not only with a result through actions to diversify funding sources and lengthen superior to the targets set for 2011, but also with a posi- debt maturities taken during the year, allowed us to im- tive net result notwithstanding the negative impact on ac- mediately embark on a new phase of expansion, particu- counts of the Pirelli Re operation. larly in rapidly developing countries. Among these expansion projects, I would note Mexico, where Pirelli’s first In the light of these results, we can look to the future with and future plant in the country will also serve Nafta area confidence and determination. And we demonstrated markets, Russia, where the finalization of agreements this with the presentation of a new industrial plan for the with local partners could lead to our having a production General information 13

Dear shareholders,

capability in the country, China, where we will extend production to include motorcycle tyres, and Italy, where the new technology hub at Settimo Torinese represents a new frontier in terms of product and process innovation, as well attention to sustainability and the environmental quality of the workplace.

The Settimo Torinese project was the result of a constant commitment to research, which was also a factor in one of our greatest successes in 2010: winning the contract as exclusive supplier to Formula One. For the 3-year period 2011-2013, the Pirelli mark will be a protagonist on the most important car circuits of the world.

This year, again, we have made ambitious commitments to you and the market. As always, we will approach them with seriousness, rigour and responsibility. Our challenge is not only to achieve them, but to exceed them again.

Thank you to all of you, our shareholders, for sharing in The chairman our commitment. Marco Tronchetti Provera 14 Annual Financial Report at December 31, 2010 Volume 1

“We love challenges. To achieve them we rely on our culture of enterprise, vigilant Governance, ambitious Sustainability goals, passion and courage” General information 15

MARCO TRONCHETTI PROVERA, Chairman Pirelli & C. S.p.A. Pirelli Foundation Bicocca, Milan

On April 14, 2010 Pirelli inaugurated the Pirelli Foundation and opened its historic archives to the city.

INDUSTRIAL CENTER Settimo Torinese

In 2010 the construction of the new industrial centre at Settimo Torinese goes ahead. This will be the most technologically advanced and efficient Pirelli Plant.

FORMULA 1 Exclusive supplier

On June 23, 2010, the FIA, the teams represented by FOTA and the Formula 1 organisation chose Pirelli as their exclusive supplier for the period 2011-2013.

The Cal 2011

On November 30, 2010 Mithology the news Pirelli’s calendar signed by Karl Lagerfeld was presented in Moscow CAR Scorpion Verde SUV tyre®

Moto Diablo Rosso II®

TRUCK The Regional ®

General information 31

Prof. Berardino Libonati, an internationally famous jurist who had served as Director of Pirelli & C. S.p.A. and as Chairman of the Remunerations Committee since 2005, died on November 30, 2010.

Professor Libonati’s passing was a harsh blow for the entire legal and corporate world.

Professor Libonati was a dedicated member of the Pirelli & C. S.p.A. Board of Directors. He also made invaluable contributions to elaboration of the Pirelli Corporate Governance system. 32 Annual Financial Report at December 31, 2010 Volume 1

DIRECTORS’ REPORT Directors’ report 33

DIRECTORS’ REPORT Russian partners for the supply and high-technology pro- ON OPERATIONS duction of synthetic rubber. This venture would fall in the framework of initiatives undertaken by Pirelli to identify raw materials to be used as alternatives and/or in addition The process of transforming the Pirelli Group into a Pure to natural rubber. Tyre Company was completed in 2010. This transforma- Additionally there are plans for an official opening of the tion was undertaken in accordance with the 2009-2011 new industrial centre at Settimo Torinese in 2011. This will business plan and completed in 2010 with the spin-off of be the most technologically advanced and efficient Pirelli Pirelli & C. Real Estate S.p.A., now Prelios S.p.A. (fol- plant for the production of High-Performance, Ultra High- lowing Pirelli RE – now Prelios) and the disposal of non- Performance and lower environmental impact tyres, as strategic assets, including Pirelli Broadband Solutions part of the Group’s established green performance strategy. S.p.A. and Oclaro Inc. (formerly Avanex). Conclusion of this process, together with the achievement of the 2011 Pirelli has always been committed to research and devel- targets a year earlier than scheduled in the 2009-2011 opment, continuous process and product innovation, and business plan, resulted in the preparation of the new busi- it has also been involved in motorsports since 1907. All ness plan for 2011-2013 with a forward view to 2015, these qualities contributed to it being named in 2010 as which was presented to the financial community on No- exclusive supplier to the Formula 1 championship for the vember 4, 2010. three-year period 2011-2013.

This plan focuses on the production for the Premium seg- The value of its investments in research and development, which is growing faster than the market as a whole, ment activity amounted to about 3% of sales in 2010, and on the development of business in rapidly developing one of the highest levels in the industry. This has enabled economies. Two such countries are Mexico, where Pirelli is Pirelli to continue turning out new patents (currently building its first local plant, and Russia, where agreements over 4,500), maintain its capacity to turn out innovative are being finalised as envisaged in a memorandum of un- Premium products, continue perfecting innovative proc- derstanding signed with the local partner Russian Tech- esses for the mixing of materials and building of tyres in nologies and local producer Sibur Holding, for the devel- all product segments, and develop alternative materials opment of joint activities in the tyre and steelcord sectors. to replace traditional ones, in view of reducing costs and There are also plans for making an agreement with these pursuing environmental sustainability. 34 Annual Financial Report at December 31, 2010 Volume 1

The construction of the industrial centre at Settimo Torinese

Pirelli finished the year with sharply higher operat- segment sales climbed by 16.7%, while Industrial segment ing results, bettering the targets announced on October sales jumped by 26.3%, with ROS (i.e. the ratio of operat- 14, 2010, which had in turn been repeatedly revised up- ing income after restructuring expenses on sales) improv- wards over the course of the year. This outstanding earn- ing to 9.6% (from 7.4% in 2009) and 9.2% (from 8.5% ings performance was due to the efficient operating man- in 2009), respectively. Overall, the ROS of Pirelli Tyre agement and the recovery in tyre sector demand, which (EBIT/sales) was 9.5%, up decisively from 7.7% in 2009. began at the end of 2009 and continued through 2010. The positive performance of operating results was sus- In regard to Group results, the activities connected with tained by volume growth at Pirelli Tyre, which now ac- Pirelli RE (now Prelios) and Pirelli Broadband So- counts for 98.4% of Pirelli Group sales, and effective lutions are considered discontinued operations and measures impacting the price/mix component. The 19.5% included in the net income (loss), so that the compara- growth in Pirelli Tyre sales (+16.2% on a comparable ex- tive figures for 2009 have been restated. The highlights change rate basis) stemmed from a 7.3% contribution by for 2010 are as follows: volume and 8.9% by the price/mix component. The price —— sales: euro 4,848.4 million, compared with the tar- component made it possible to offset the growth in costs get of “about euro 4.8 billion,” up 19.2% from 2009. for productive factors, particularly raw materials, while Of this amount, 37% was generated by “green” ac- the mix component permitted expansion of the product tivities (25% for 2009); range in the Premium segment, on which the Company —— EBIT margin after restructuring expenses: has focused its business. 8.4% as compared with the target of “over 7.5%; Based on volumes, sales recovered in all geographical ar- —— net financial position: negative for euro 455.6 mil- eas, in both sales channels (Replacement and Original lion, compared with the target of “less than euro 700 Equipment) and in the different business units. Consumer million.”. Directors’ report 35

Over the year, the refocus on the Group’s industrial activ- SIGNIFICANT EVENTS DURING ities in the tyre sector led to the spin-off of Pirelli RE (now THE YEAR Prelios) from the Pirelli & C. S.p.A. Group (concluded on October 25, 2010 with the assignment of Pirelli RE (now Prelios) shares to the shareholders Pirelli & C. S.p.A. and On January 19, 2010, the Pirelli & C. S.p.A. Block Share- a consequent voluntary reverse stock split by the latter) holders Agreement was renewed with expiry on April 15, and disposal of Pirelli Broadband Solutions S.p.A. 2013. All parties to the agreement had expressed their intention to renew the agreement by January 15, 2010, Even when the impact of these discontinued operations is the contractual deadline for any withdrawals. included (aggregate net loss of euro 223.8 million), consolidated net income amounted to euro 4.2 million at On April 14, 2010 Pirelli inaugurated the Pirelli Foun- December 31, 2010, compared with a consolidated net dation and opened its historic archives to the city. These loss of euro 22.6 million in 2009. Consolidated net in- archives represent the “heart” of the Foundation. come attributable to owners of the Parent was euro Marco Tronchetti Provera, Alberto Pirelli, Cecilia Pirelli 21.7 million, compared with euro 22.7 million in 2009. and Antonio Calabrò, Foundation Director, attended Consolidated net income before the effect of dis- the opening. The Pirelli Foundation, founded in 2009, continued operations was euro 228.0 million, almost has an international outlook, promoting and spreading three time the amount of euro 77.6 million reported in the Group’s cultural, historic and documentary heritage, 2009. which represents an integral part of Italian business, social and intellectual history. The objectives of the Foun- Consolidated operating income, which reflects euro dation include the promotion and appreciation of cultur- 24.7 million in restructuring expenses (euro 55.2 million al initiatives that are related to and consistent with Pirelli in 2009), was euro 407.8 million, compared with euro corporate culture. 249.7 million in 2009, and the ROS was 8.4%, compared The Historic Archives preserve documents, writings, with 6.1% in 2009. films, objects, art works and photographs that cover the

Consolidated net financial (liquidity)/debt position at December 31, 2010 is negative for euro 455.6 million Pirelli Foundation (after having paid euro 81 million in dividends to shareholders), compared with a negative net financial position of euro 528.8 million at December 31, 2009. This reduction reflected the proceeds from disposal of non-strategic assets and especially the contribution made by Pirelli Tyre operating cash flow (positive euro 167.7 million, compared with euro 395.4 million in 2009), despite the near doubling in capital expenditure (euro 405.0 million in 2010, compared with euro 217.4 million in 2009), in particular on projects to expand production capacity.

Growing sales volumes, continuous price/mix adjustments, and continuing cost-cutting measures enabled Pirelli Tyre to counter effectively rising costs for product inputs, specifically raw materials, and conclude the financial year with positive results that easily topped targets: —— sales: euro 4,772.0 million, compared with the target of “over euro 4.7 billion,” up 19.5% from 2009; —— EBIT margin after restructuring expenses: 9.5%, higher than both the target of “more than 8.5%” and the 7.7% achieved in 2009. 36 Annual Financial Report at December 31, 2010 Volume 1

138 years of Company industrial and cultural history, The spin-off resulted in the proportional assignment of from its foundation in 1872 to the present day. 487,231,561 ordinary shares in Pirelli RE (now Prelios) to Pirelli & C. S.p.A. based on a ratio of one Pirelli RE On May 4, 2010 the Board of Directors of Pirelli & C. (now Prelios) share for each Pirelli & C. S.p.A. ordi- S.p.A. resolved to submit a motion to the Shareholders nary or savings share owned, compared to a total of for approval of a spin-off of the assets and activities of 487,798,972 shares owned by Pirelli & C S.p.A.(after Pirelli RE (now Prelios) from the other activities oper- the reverse stock split at the ratio of 1 new share for ated by the Pirelli Group. The purpose of this spin-off every 11 shares owned) prior to the spin-off. The failure was to focus Pirelli Group activities on the tyre business to assign all the Pirelli RE (now Prelios) shares owned is in view of streamlining its operations as part of the pro- due entirely to technical reasons, in order to determine gramme launched in 2008 and continued in 2009. This an unfractioned ratio of assignment to the shareholders programme was outlined in the 2009-2011 three-year of Pirelli & C. S.p.A. strategic business plan, while simultaneously allowing its shareholders, who already had an indirect equity interest On June 22, 2010 Pirelli & C. Ambiente S.p.A., the in the Real Estate business, to acquire a direct sharehold- Pirelli Group company operating in the renewable en- ing in Pirelli RE (now Prelios). ergy sources sector, signed a licensing agreement with The spin-off was executed by assigning to Pirelli & Bosco International, which promotes environ- C. S.p.A. shareholders almost all of the or- mentally sustainable industrial systems and dinary shares of Pirelli RE (now Prelios) processes. The agreement will allow the owned by the Company, representing Australian company to use the Pirelli about 58% of the share capital. This patent for production of high quality was carried out through a reduc- On June 23, solid recovered fuel (HQ-SRF) de- tion in share capital whose actual 2010, the FIA, the rived from municipal solid waste amount was determined by the (MSW). Extraordinary Shareholders’ teams represented by Pirelli technology will initially be Meeting of Pirelli & C. S.p.A. FOTA and the Formula 1 used in the Latrobe area, in the on July 15, 2010, and equal to organisation chose Pirelli Australian state of Victoria, as the fair value of the investment part of the “Towards Zero Waste in Pirelli RE (now Prelios) being as their exclusive supplier Policy” programme introduced assigned (euro 178,813,982.89). for 2011-2013. by local government authori- That fair value had been deter- ties for containment of waste. Its mined on the basis of the official goal is to convert the 600 thousand price of Pirelli RE (now Prelios) shares tonnes of MSW produced annually by (euro 0.367) quoted on July 14, 2010, the city of Melbourne into HQ-SRF. In the trading date prior to the Extraordinary particular, the exchange of technology will Shareholders’ Meeting. stimulate investment by Bosco International to de- Pursuant to Article 2445(3) Italian Civil Code, the spin- velop an HQ-SRF plant in Australia, once authorisation off was completed on October 25, 2010, 90 days after is obtained from local authorities. According to a study the resolution by the Extraordinary Shareholders’ Meet- conducted by Milan Bicocca University on the Life Cycle ing of Pirelli & C. S.p.A. had been recorded at the Com- Assessment (LCA) method, the use of Pirelli HQ-SRF panies Register. is 90 and 72 times more beneficial for the environment In accordance with accounting rules, the Parent Pirelli & than alternative systems such as waste dumps and waste C. S.p.A. restated the liability resulting from the spin-off to energy plants, respectively. on its separate financial statements, on the basis of the official price of Pirelli RE (now Prelios) shares reported on On June 23, 2010, the FIA (Fédération Internationale de the previously mentioned closing date of the spin-off (euro l’Automobile), the teams, represented by FOTA (Formu- 0.4337). This restatement resulted in that liability increas- la One Team Association), and the Formula 1 organisa- ing from euro 178,813,982.89 to euro 211,312,328, with a tion, represented by FOM (Formula One Management), change in Equity of euro 32,498,345. At the same time, it chose Pirelli as their exclusive supplier, after approving recognised a loss of about euro 118.3 million in the income the solutions proposed by the Italian Group aimed at statement, with this amount corresponding to the differ- guaranteeing technological and qualitative continuity to ence between the value of the restated liability as indicated the competitive teams. In accordance with current For- above and the book value of Pirelli RE (now Prelios) shares. mula 1 regulations issued by FIA, the supply agreement The impact of the spin-off on the consolidated financial envisages that Pirelli provide the teams with six differ- statements was negative for approximately euro 219 million. ent types of tyres for the entire season: four slick type Directors’ report 37 38 Annual Financial Report at December 31, 2010 Volume 1

tyres, made of different compounds for use in races on Inc., through its subsidiary GWM Renewable Energy dry asphalt; one rain tyre, developed for heavy rain; and S.p.A., signed a strategic agreement for joint develop- an intermediate type tyre for use on damp asphalt and in ment of business in the photovoltaic sector in Italy. In light rain. performance of this agreement, Solar Utility S.p.A., The new global economic situation has imposed a realis- a wholly-owned subsidiary of Pirelli & C. Ambiente tic, collaborative approach for sharing the industrial and S.p.A. operating in the photovoltaic sector, granted its logistic costs related to supply of the tyres with the teams. production assets to a new company named GP Ener- Pirelli’s return to Formula 1 originated with the prospect, gia S.p.A., of which GWM Renewable Energy S.p.A. previously agreed with the teams, to undertake wide- acquired 60% of the share capital. The remaining 40% ranging research on technically innovative solutions for was initially owned by Solar Utility S.p.A. (now 35%). technological evolution of current tyres in various con- The initial value of the joint venture amounts to about texts. euro 20 million, and it aims to acquire about 100 MW Pirelli has also been engaged as exclusive supplier to the of capacity in Italy. GP2 Series World Championship for the three-year period 2011-2013. On September 23, 2010 Pirelli opened the “Factory of The Company’s upcoming participation in these cham- Champions” at the Izmit industrial centre in Turkey. This pionships comes on top of its participation in the GP3 is the plant where the Group will make the tyres to be Series since 2010, making Pirelli the official supplier for used by all Formula 1 teams for the three-year period the most prestigious one-seater car races in the world. 2011-2013. The Izmit facility, which celebrated its fif- Pirelli will also invest in advertising to promote tieth anniversary in 2010, has been home to the industrial and technological commit- motorsport tyre production since 2007 ment required for participation in For- and will soon become the heart of mula 1, dedicating resources previ- Pirelli Formula 1 activities, together ously budgeted by the Company for with the Milan research and devel- this new venture. This advertising opment centre. The Izmit plant will focus primarily in support of The supply of produces 8 million motorsport, the expected growth by Pirelli tyres to Formula car and truck tyres annually, the operations in developing econo- highest output of any Pirelli fac- mies such as Latin America and One is inspired by tory. the Asia-Pacific areas, where With the start-up of the Formula numerous Formula 1 events are our criteria of 1 division, Pirelli is now expand- scheduled to be held. ing its production line to make Formula 1 will thus become an sustainability tyres for all automotive sports ac- important driving force for further tivities. In 2011, the Company will promotion of the Pirelli brand and its produce a total of 200 thousand rac- commercial and industrial growth, with- ing tyres, including 50 thousand tyres out involving any changes to the Company’s for F1 teams and about 70 thousand for the business and financial plans. The global visibil- GP2 and GP3 championships, of which Pirelli is ity resulting from Formula 1 media coverage and brand the exclusive supplier. promotion activities closely linked to the Company’s core The remainder will go to the 60 international road and business will enable Pirelli to maximise the return on its track competitions for which the Milan-based tyre mak- advertising investment. er is the sole supplier, as well as to the most prestigious The Formula 1 supply agreement crowns the long-stand- single-brand championships, such as the Ferrari Chal- ing commitment of Pirelli to car racing, dating back to lenge, Lamborghini Super Trofeo and Maserati Trofeo. 1907, when the Italian Group won the Peking-Paris Raid. Overall, the complete Pirelli automotive sports range is Pirelli is currently the exclusive supplier to the world’s represented by 200 types of racing tyres, including rally most important car and motorcycle races, such as the tyres. GP3 World Championship, the WRC World Rally Cham- The Izmit facility, in synergy with the Pirelli centre for pionship, the Rolex Sports Car Series in North America, preparation of sports tyres at Burton-on-Trent, England, the Superbike World Championship and the Motocross will also be the centre of all Formula 1 logistics activities. World Championship. It is also involved in over 70 other In line with the Pirelli Group green performance strategy, national and international championships. aimed at developing products and solutions that combine maximum performance and safety with respect for the On July 15, 2010 Pirelli & C. Ambiente S.p.A., through environment, Formula 1 production is based on the prin- its subsidiary Solar Utility S.p.A., and GWM Group ciples of environmental sustainability. Directors’ report 39

On October 20, 2010 Pirelli illustrated its development quisition by ADB of 100% of the share capital of Pirelli plans in Argentina, where the Group began operations Broadband Solutions S.p.A. (PBS), a wholly-owned sub- 100 years ago. These plans, which aim to increase pro- sidiary of Pirelli & C. S.p.A. This transaction was com- duction capacity and to consolidate the leadership of pleted on November 29, 2010, with the sale by Pirelli of Pirelli in Latin America, are part of the Company’s inter- 100% of PBS to the ADB Group. The price paid by ADB national expansion strategy. Over these last several years, consisted of about euro 25 million in cash and 400 thou- that strategy has steadily expanded its direct industrial sand listed shares in ADB, representing approximately operations in the markets that offer higher growth rates 7.2% of its share capital. Pirelli & C. agreed to a lock-up and competitive industrial costs. In particular, expansion of these shares for the first two months afterclosing , while of its presence in Argentina ensures that Pirelli has a ma- an agreement for a Pirelli put option and an ADB call op- jor platform both for meeting growing demand on the tion were also signed, exercisable within two years. domestic market, which is allocated about 50% of out- The divestiture of the Pirelli Broadband Solutions busi- put, and satisfying demand on important export markets, ness is part of Pirelli’s stated strategy of focusing on its especially Brazil and the United States. core tyre business. Its sale to a leading industrial Group is intended to ensure the continued growth and develop- On October 21, 2010 Pirelli & C. S.p.A. and Advanced ment of PBS on the broadband access systems market. Digital Broadcast Holdings SA (ADB), a company listed The deal contributed about euro 21 million to consoli- on the Swiss stock exchange, signed an agreement for ac- dated income.

Chairman Pirelli & C. S.p.A, Marco Tronchetti Provera with Argentinian President Cristina Fernández de Kirchner 40 Annual Financial Report at December 31, 2010 Volume 1

On November 26, 2010 Pirelli, Russian Technologies the production of steelcord, the metallic cord used in ra- and Sibur Holding signed a memorandum of understanding dial tyres and giant tyres, at Samara, in the Togliatti spe- (MOU) in Moscow to define a series of agreements for cial economic zone. the development of joint activities in the tyre and steel- On November 30, 2010 Pirelli signed a new, five-year record sectors, as well as the supply and high-technology volving credit line agreement worth euro 1.2 billion, which production of synthetic rubber derivatives in Russia. The will replace existing lines of credit for a total of euro 1.475 closing is expected to take place by June 2011. Regarding billion granted in 2005 and 2007 and having maturities in the tyre sector in particular, the agreement lays the basis 2011 and 2012, which will consequently be cancelled in for joint launch of a process to streamline and reorgan- advance. The 2015 maturity is aligned with the time hori- ise the tyre activities of Sibur Holding, one of the largest zon of the recently presented Pirelli business plan. Execu- Russian operators in the petrochemical sector. The agree- tion of this new agreement is one of the actions aimed at ments envisage a process of reorganisation to select the streamlining Group debt, by lengthening its average dura- assets of Sibur Russian Tyres that will be granted to two tion and diversifying funding sources. The loan agreement joint ventures set up by Pirelli and Russian Technologies was made with twelve major Italian and foreing banks. (JV1 and JV2). This process will be based on guidelines The credit line is subject to a floating rate, with the initial and business plans drawn up jointly by the three partners. interest rate set at Euribor plus 110 basis points. The first joint venture will receive the assets of Sibur Russian Tyres that are convertible to Pirelli standards in On December 10, 2010 the Ministry for Equal Op- the car, agro radial and truck all steel sectors. Certain of portunity, the Region of Lombardy and Pirelli signed these assets, pending finalisation of the transactions, will an agreement to expand and renew until 2013 the in- be managed by Pirelli from the outset on the basis of a ternational health cooperation programme launched in “manufacturing and technology agreement”. 2008 between the Milan Niguarda Ca’ Granda Hospital The second joint venture, instead, will receive the assets and Slatina Hospital in Romania. This programme aims that can be used for original equipment car tyres, target- to support the professional training of Romanian medi- ing growing demand on the Russian market, as well as cal and nursing professionals through a training course the assets for production of truck and conventional agro coordinated by the Milan hospital. Pirelli will contribute tyres. JV2 will also hold a significant stake in Sibur Rus- about euro 0.4 million to the project over the three-year sian Tyres. Pirelli will also directly acquire 10% of Sibur duration of the agreement, which will bring its total com- Russian Tyres in exchange for signing an agreement to mitment to the project to over euro 1 million since its provide its technical and managerial input. To this end, launch. The agreement is part of the social initiatives that Pirelli will provide its technologies and production proc- Pirelli undertakes in support of local communities wher- esses under license, participate in technological upgrade ever it has production facilities. of the plants, and provide its know-how in the areas of logistics, quality control and organisation. The tyre activities of the Sibur Group will benefit from cutting-edge Pirelli technology. With industrial support from the Italian Group, Sibur expects to significantly improve its own business results. The new technological tie-up between the two Groups in the synthetic rubber sector will also facilitate the introduction of new kinds of synthetic rubber to improve tyre performance, especially in high-end products, where this component is more important than natural rubber. The agreement will also help create synergies between the automotive, tyre and synthetic rubber sectors in Rus- sia, improve the products offered to customers and en- hance the international competitiveness of the Russian tyre and automotive industry. The partnership between Russian Technologies, Sibur and Pirelli will also support the development of the Russian automotive and tyre industries and, by attracting investment to the tyre sector, enable the creation of modern high-technology and high- quality products for both industries. This agreement will lead Pirelli to have its own production plants ever in the Russian Federation. Also within the scope of the MOU, Pirelli and Russian Technologies will build a factory for Directors’ report 41

Slatina hospital 42 Annual Financial Report at December 31, 2010 Volume 1

THE GROUP The Group 43

SELECTED ECONOMIC —— Non-current assets: this measure is the sum of AND FINANCIAL DATA “property, plant and equipment,” “intangible assets,” “investments in associates and joint ventures” n addition to the financial performance measures es- and “other financial assets”; tablished by the International Financial Reporting —— Provisions: this measure is the sum of “provisions IStandards (IFRSs), this report presents certain meas- for liabilities and charges (current and non-current),” ures that are derived from, although not required by IFRSs “provisions for employee benefits” and “provisions (“Non-GAAP Measures”). These performance measures for deferred tax liabilities”; are presented to facilitate the understanding of the Group —— Net working capital: this measure consists of all operating performance and should not be considered as items not included in the two measures above, in substitutes for the information required by IFRSs. “Equity” and “net financial (liquidity)/debt position”; Specifically, the Non-GAAP Measures used are the following: —— Net financial (liquidity)/debt position: this per- —— Gross Operating Profit (EBITDA): this financial formance measure is represented by gross financial measure is used by the Group as a financial targetfor debt less cash and cash equivalents and other finan- internal presentations (business plans) and external cial receivables. The section “Explanatory notes to the presentations to analysts and investors. It is a use- consolidated financial statements” presents a table ful unit of measurement to assess the overall oper- showing the line items used to calculate this measure. ating performance of the Group and its individual Recalling that the figures for the activities of Pirelli RE business segments in addition to operating income. (now Prelios) and Pirelli Broadband Solutions are shown Gross operating profit is an intermediate economic in the income statement under “discontinued operations”, measure deriving from operating income, but ex- and that the 2009 figures have been restated for compara- cluding depreciation and amortisation of property, tive purposes, the Group’s consolidated accounts may be plant and equipment and intangible assets; summarised as follows: (in millions of euro) 12/31/2010 12/31/2009 Net sales 4,848.4 4,067.5 Gross operating profit before restructuring expenses 653.7 507.8 % of net sales 13.5% 12.5% Operating income before restructuring expenses 432.5 304.9 % of net sales 8.9% 7.5% Restructuring expenses (24.7) (55.2) Operating income 407.8 249.7 % of net sales 8.4% 6.1% Net income (loss) from equity investments 23.4 (11.6) Financial income/(expenses) (65.8) (70.1) Income tax (137.4) (90.4) Net income (loss) from continuing operations 228.0 77.6 Net income (loss) from discontinued operations (223.8) (100.2) Total net income (loss) 4.2 (22.6)

Net income attributable to owners of Pirelli & C. S.p.A. 21.7 22.7 Total net earnings per share attributable to the owners of Pirelli & C. S.p.A. (in euro) * 0.044 0.047

Non-current assets 3,164.1 3.596.2 Net working capital 116.7 221.8 Net invested capital 3,280.8 3,818.0 Equity 2,028.0 2,494.7 Provisions 797.2 794.5 Net financial (liquidity)/debt position 455.6 528.8

Equity attributable to the owners of Pirelli & C. S.p.A. 1,990.8 2,175.0 Equity per share attributable to the owners of Pirelli & C. S.p.A. (in euro) * 4,080 4,457

Capital expenditure 433.1 225.2

Research and development expenses 149.7 137.1 % of net sales 3.1% 3.4%

Employees (number at end of period) 29,573 29,570 Industrial sites (number) 20 21

Pirelli & C. S.p.A. shares Ordinary shares (number in millions) 475.7 5,233.1 of which treasury shares 0.4 3.9 Savings shares (number in millions) 12.3 134.8 of which treasury shares 0.4 4.5 Total shares (number in millions) 488.0 5,367.9 * The equity per share attributable to owners of the Company in 2009 has been restated on a comparable basis after the reverse stock split pursuant to the Shareholders’ Meeting resolution of July 15. 2010 (at a ratio of 1:11). 44 Annual Financial Report at December 31, 2010 Volume 1

To facilitate understanding of Group performance, the income data and net financial (liquidity)/debt position are presented below as broken down by business segment.

(in millions of euro) Tyre Other businesses * Total 2010 2009 2010 2009 2010 2009 Net sales 4,772.0 3,992.9 76.4 74.6 4,848.4 4,067.5 Gross operating profit before restructuring expenses 684.3 538.0 (30.6) (30.2) 653.7 507.8 Operating income before restructuring expenses 476.3 345.5 (43.8) (40.6) 432.5 304.9 Restructuring expenses (23.2) (37.0) (1.5) (18.2) (24.7) (55.2) Operating income 453.1 308.5 (45.3) (58.8) 407.8 249.7 Net income (loss) from equity investments 0.3 4.2 23.1 (15.8) 23.4 (11.6) Financial income/(expenses) (66.4) (76.1) 0.6 6.0 (65.8) (70.1) Income tax (134.4) (90.0) (3.0) (0.4) (137.4) (90.4) Net income (loss) from continuing operations 252.6 146.6 (24.6) (69.0) 228.0 77.6 Net income (loss) from discontinued operations (223.8) (100.2) Net income (loss) 4.2 (22.6) Net financial (liquidity)/debt position of continuing operations 1,109.9 1,027.3 (654.3) (504.1) 455.6 523.2 Net financial (liquidity)/ debt position of discontinued operations 5.6 Net financial (liquidity)/debt position 455.6 528.8

* This item includes the Pirelli Eco Technology Group, the Pirelli Ambiente Group, PZero S.r.l., all holding companies (including the Parent), the other service companies and, for the item “net sales”, elimination of intercompany transactions

NET SALES the year of about euro 3 million, but also its impairment Net sales in 2010 totalled euro 4,848.4 million, up 19.2% to value in use by an additional euro 0.5 million, or euro from euro 4,067.5 million in 2009. 1.48 per share. The percentage breakdown of activities shows that 98.4% of In 2009 this item was largely impacted by the negative ef- sales were generated by the tyre business (98.1% in 2009). fect from disposal of the remaining equity investment in Telecom Italia S.p.A. (euro 17.5 million). OPERATING INCOME Operating income before restructuring expenses totalled euro 432.5 million (8.9% of sales), compared with NET INCOME (LOSS) euro 304.9 million (7.5% of sales) in 2009. Net income from continuing operations was euro Restructuring expenses totalled euro 24.7 million, 228.0 million, nearly triple the amount of euro 77.6 mil- as compared with euro 55.2 million in 2009, and stem lion generated in 2009. This change resulted primarily mainly from on-going measures launched in 2009 to from the improvement in operating income. streamline Pirelli Tyre staff organisations in Europe (euro The net loss from discontinued operations, totalling 23.2 million, compared with euro 37 million in 2009). euro 223.8 million, related to the activities of the Pirelli RE Operating income totalled euro 407.8 million, com- (now Prelios) Group and Pirelli Broadband Solutions that pared with euro 249.7 million the previous year. were sold in 2010. In regard to Pirelli RE (now Prelios), the result consists of the operating loss for the first nine months of 2010 NET INCOME (LOSS) FROM EQUITY (euro 29 million, compared with euro 104.8 million for INVESTMENTS all of 2009), the loss on assignment of Pirelli & C. S.p.A. Net income from equity investments was euro 23.4 mil- shares (euro 156.3 million), the derecognition of the good- lion, compared with a net loss of euro 11.6 million in the will previously allocated on asset (euro 32.9 million), the previous year. The figure for 2010 consists principally of riclassification to income statement of gains/losses previ- the proceeds from disposal of the entire investment held in ously recognized in Equity (euro 32.2 million), the reversal Oclaro Inc. (formerly Avanex), which generated a gain of of a real estate gain previously eliminated in the consoli- euro 18.4 million, in addition to euro 5.8 million earned dated financial statements (euro 3.7 million), and spin-off as dividends on financial investments and the recognition expenses (euro 1.2 million). of associates in Equity. In this last category, the carrying Pirelli Broadband Solutions contributed a total of euro value of the associate RCS MediaGroup S.p.A. (RCS) not 24.1 million to net income, including euro 21.1 million for only reflected the Group’s interest in the RCS net loss for the gain realised on disposal of the equity investment and The Group 45

euro 3.4 million in operating income for the first nine EQUITY months of 2010 (euro 4.6 million in all of 2009), net of disposal costs (euro 0.4 million). Consolidated Equity fell from euro 2,494.7 million at December 31, 2009 to euro 2,028.0 million at Decem- Total net income was euro 4.2 million, compared with ber 31, 2010. a net loss of euro 22.6 million in the previous year. Equity attributable to owners of Pirelli & C. S.p.A. at December 31, 2010 was euro 1,990.8 million, com- The total net income attributable to owners of pared with euro 2,175 million at December 31, 2009. Pirelli & C. S.p.A. was euro 21.7 million (euro 0.044 per share), compared with euro 22.7 million (euro 0.047 The change is summarised as follows: per share) the previous year.

(in millions of euro) Non-controlling Group Total interests Equity at 12/31/2009 2,175.0 319.7 2,494.7 Translation differences 101.4 3.3 104.7 Net income (loss) from continuing operations 233.8 (5.8) 228.0 Net income (loss) from discontinued operations (212.0) (11.8) (223.8) Adjustment to fair value of other financial assets/derivative instruments (45.5) - (45.5) Other changes to items recognised in Equity for continuing operations 3.9 - 3.9 Net actuarial gains/(losses) on employee benefits (21.6) - (21.6) Total items recognised in Equity for discontinued operations 36.6 3.3 39.9 Reduction for spin-off of Pirelli RE (now Prelios) (215.3) (274.8) (490.1) Dividends paid (81.1) (4.0) (85.1) Venezuela inflation effect 15.0 0.6 15.6 Capital increases - 4.8 4.8 Other changes 0.6 1.9 2.5 Total changes (184.2) (282.5) (466.7) Equity at 12/31/2010 1,990.8 37.2 2,028.0

The statement of reconciliation between the Equity of the Parent Pirelli & C. S.p.A. and the consolidated Equity attributable to the owners of the Parent is presented below, pursuant to the Consob Comunication of July 28, 2006.

(in millions of euro) Share Treasury Net Total capital reserves income Equity of Pirelli & C. S.p.A. at 12/31/2010 1,375.7 121.5 87.4 1.584.6 Net income for the year of consolidated companies (before consolidation adjustments) - - 261.9 261.9 Share capital and reserves of consolidated companies (before consolidation adjustments) - 818.4 - 818.4 Consolidation adjustments: —— carrying value of equity investments in consolidated companies - (668.9) - (668.9) —— intercompany dividends - 258.8 (258.8) - —— others - 63.7 (68.9) (5.2) Consolidated equity of group at 12/31/2010 1,375.7 593.5 21.6 1,990.8 46 Annual Financial Report at December 31, 2010 Volume 1

+4.2 million euro TOTAL NET INCOME The Group 47

NET FINANCIAL (LIQUIDITY)/DEBT POSITION euro 455.6 million at December 31, 2010. The change for the year is summarised by the following The Group’s net financial position which was negative for cash flow, which totalled a positive euro 73.2 million: euro 528.8 million at December 31, 2009 improved to

(in millions of euro) Q1 2010 Q2 2010 Q3 2010 Q4 2010 2010 2009 Operating income (EBIT) before restructuring expenses 90.2 109.6 119.9 112.8 432.5 304.9 Amortisation and depreciation 51.7 53.7 55.0 60.8 221.2 202.9 Purchase of property. plant and equipment and intangible assets (49.9) (85.2) (91.5) (212.0) (438.6) (223.8) Change in working capital/other (143.5) 42.2 (18.0) 214.5 95.2 211.7 Operating cash flow (51.5) 120.3 65.4 176.1 310.3 495.7 Financial income/(expenses) (17.6) (22.9) (14.0) (11.3) (65.8) (70.1) Income tax (30.4) (40.0) (40.1) (26.9) (137.4) (90.4) Net operating cash flow (99.5) 57.4 11.3 137.9 107.1 335.2 Financial investments/disinvestments - - 9.8 21.9 31.7 219.1 Dividends paid - (85.1) - - (85.1) (2.4) Cash out for restructuring expenses (34.0) (9.9) (7.4) (2.0) (53.3) (65.8) Net cash flow of Pirelli Broadbands Solutions (12.1) 0.7 (11.4) (12.9) (35.7) 20.7 Net cash flow of Pirelli RE (now Prelios) (14.0) (6.5) (26.5) 88.3 41.3 248.2 Pirelli RE (now Prelios) rights issue subscribed by Pirelli & C. S.p.A. - - - - - (231.9) Foreign exchange differences/other 10.0 24.9 16.2 16.1 67.2 (24.2) Net cash flow (149.6) (18.5) (8.0) 249.3 73.2 498.9

The following table breaks down the net financial position by business segment:

(in millions of euro) Tyre Other Corporate Consolidated businesses continuing operations Gross debt 1,613.6 83.3 123.0 1,147.0 of which due to Corporate 589.6 83.3 Financial receivables (98.3) (4.8) (806.7) (236.9) of which receivable from Pirelli RE (now Prelios) (140.4) (140.4) Cash. cash equivalents. securities held for trading (405.4) (6.6) (42.5) (454.5) Net financial (liquidity)/debt position 1,109.9 71.9 (726.2) 455.6

The column “Other businesses” includes Pirelli & C. Eco Technology. Pirelli & C. Ambiente and PZero

The financial receivables include use of the credit facility This credit facility complements the bank credit facilities granted to Pirelli RE (now Prelios) for euro 150 million, available to Pirelli RE (now Prelios). due in July 2012 or July 2017 (depending on whether Pirelli RE - now Prelios - fails to realise the targets set in The structure of gross debt is broken down by type and its business plan), referring to assignment of its shares. maturity as follows:

(in millions of euro) Financial Maturity date Statements 2011 2012 2013 2014 and beyond 12/31/2010 Use of committed credit facilities 380.0 - - - 380.0 Other financing 767.0 252.0 146.7 92.0 276.3 Total gross debt 1,147.0 252.0 146.7 92.0 656.3 22.0% 12.8% 8.0% 57.2% 48 Annual Financial Report at December 31, 2010 Volume 1

At December 31, 2010 the Group had unused committed EMPLOYEES credit facilities totalling euro 1,220 million, with the liquid- Group headcount at December 31, 2010 was 29,573 ity margin (construed as the sum of liquidity and unused (including 2,426 temporary workers), as compared credit facilities) consequently totalling euro 1,674 million. with 28,303 employees at December 31, 2009 on a comparable consolidation basis (29,570 employ- CAPITAL EXPENDITURE ees overall), i.e. net of employees at Pirelli RE (now Capital expenditure during the period, totalling euro Prelios) and Pirelli Broadband Solutions, which were 433.1 million, was concentrated in Pirelli Tyre (euro sold in 2010. 402.1 million, or 93% of the total), and mainly targeted growth and expansion in production capacity.

GEOGRAPHICAL AREAS 12/31/2010 12/31/2009 Europe: —— Italy 3,587 12.13% 4,454 15.07% —— Rest of Europe 7,714 26.09% 8,156 27.58% Nafta 285 0.96% 280 0.95% Central and South America 12,522 42.34% 11,722 39.64% Middle Est/Africa 2,983 10.09% 2,834 9.58% Asia/Pacific 2,482 8.39% 2,124 7.18% 29,573 100.00% 29,570 100.00%

BUSINESS SEGMENTS 12/31/2010 12/31/2009 Tyre 28,865 97.60% 27,481 92.94% Eco Technology 295 1.00% 284 0.96% Real Estate - - 1,139 3.85% Broadband Solutions - - 128 0.43% Other businesses 413 1.40% 538 1.82% 29,573 100.00% 29,570 100.00%

RESEARCH AND and commercial vehicles), and develop alternative mate- DEVELOPMENT ACTIVITIES rials to replace traditional ones. This will reduce production costs and improve the environmental sustainability of Group products. Pirelli Group research and development activities are key The exchange of know-how amongst the Group’s various to pursuit of its growth strategy. Product and process in- businesses, partnership with best-of-class suppliers and novation and exploitation of new business opportunities continuous collaboration with leading university research depend on Reseach and Development. centres and major car makers provide the Group with the Group reseach and development costs, which are fully technology necessary to develop cutting-edge products, expensed in the annual income statement, totalled euro which are successfully tested in the most important mo- 150 million, representing a 3.1% ratio to sales. torsport disciplines and then put on the road to satisfy Research and development activities are concentrated in specific customer requirements. Pirelli Tyre, with costs of euro 146 million. This Group Traditionally focused on the development of new high- subsidiary has a research centre in Italy and eight applica- end products (UHP, winter, runflat, SUV and motorcy- tion centres worldwide, and is staffed by over 1,000 em- cle tyres), Reseach and Development activity has been ployees – 60% of whom are from countries other than Italy. complemented by increasing strategic attention to the The value of investments in research activity is expected reduction of environmental impact, through the exploita- to remain at about 3% of sales over the next three years, tion of technological components and the most advanced one of the highest levels in the industry. All of these fac- know-how. These resources are the result of intense re- tors will enable the Group to increase the number of its search on materials, prototypes, profiles, tread patterns patents (currently over 4,500), maintain its capacity to and processes. produce innovative Premium products, continue perfect- As a result of its research and development activity in ing innovative processes used for materials mixing and 2010, Pirelli has confirmed its leadership as measured by tyre building in all product segments (car, motorcycle performance, safety and ecocompatibility, demonstrating The Group 49

that it has fully adopted the philosophy and fundamental —— technological partnerships with other leaders in the values of Green Performance. industry. Pirelli has collaborated for several years This Green Performance strategy is based on comprehen- with several of the world’s most important research sive technological innovation: institutions, including the Milan Polytechnic, the Tu- —— engineering times and costs have been substantially rin Polytechnic, the University of Craiova and Shan- reduced, with a consequent positive impact on to- dong University, while it develops new technology tal product cost. In the production processes area, on an “open innovation” basis with STM, Comau, the application of cutting-edge systems like MIRS Sinteco, Evotek and many other industrial partners; (a robotised tyre production process owned exclu- —— development of the technological and production sively by Pirelli) and the innovative compound sys- centre at Settimo Torinese, with the aim of creating tem CCM (Continuous Compound Mixing System) the Group’s most technologically advanced and ef- make it possible to develop products by means of ex- ficient “green” tyre production facility. This project tremely high quality and flexible processes using low is part of a process that guarantees higher standards amounts of energy; of factory efficiency and productivity. —— use of new organic bio-materials, with a beneficial Pirelli is also in the vanguard with development of the Cy- impact on the environment and costs. Plans call ber Tyre project. This is an intelligent tyre that can transmit for development of Green Performance products information to the vehicle essential for its stability and driv- in different segments, especially by reinforcing the ing safety. In 2010, the Cyber Tyre Lean sensor was given Group’s leadership in the Premium segment; its world première at Geneva. The sensor complies with the 50 Annual Financial Report at December 31, 2010 Volume 1

new European standard that requires adoption of a system —— Scorpion ATR won the “AutoBildallrad” test of safe- for measuring the pressure of tyres on all vehicles that are ty and grip on all types of terrain; newly approved for road use beginning in 2012. This devel- —— Cinturato P6 was ranked “highly recommended” by opment was realised in collaboration with Schrader-Tom- ADAC for its excellent balancing, performance on kin, leading world maker of pressure sensors, and marks the wet pavement, and low wear; first step towards the creation of a sensor-equipped tyre that —— Cinturato P7 is “highly recommended” by ADAC, can communicate with vehicle control systems for the reali- “AutoZeitung” and “Automotorsport” for its excel- sation of new vehicle safety functions while simultaneously lent balancing, low rolling resistance and sportiness;. providing data useful for designing and perfecting the tyre. —— Chrono was recognised by “Promobil” for its excel- The Group has received various forms of recognition for lent braking on wet and dry payment and aquaplan- its research activity. ing performance. Pirelli was recognised as the best tyre supplier of the year Positive recognition was also received from China. Ac- in Japan. This award was received from Autobacs, the cording to the magazine “Auto news,” the Pirelli Cintura- historic Japanese reseller of automotive spare parts and to P7 is “The best balanced tyre of the year.” The Cintu- accessories founded in 1947 with locations worldwide. It rato P7 stood out for its road hold, stability, tread pattern awarded Pirelli for the major contribution made to Auto- optimised to reduce its noise level and the low-carbon bacs sales in 2009, which were driven by the success of emissions production process. Pirelli was considered the the P4 Four Season. best brand on the Chinese spare parts market. This was Another form of recognition came in the form of the the finding made by the China Automobile Aftermarket “Original Equipment Tire Satisfaction Index Study”, con- Summit, the forum that is held in Beijing at the end of ducted by the prestigious JD Power & Associates research April, and promoted by the prestigious magazine “Motor institute, which annually surveys the general level of driv- Trend.” er satisfaction. This study showed that American drivers Twenty-seven tyre brands competed for the prize. They prefer Pirelli high-performance tyres for sports cars. were reviewed by industry experts attending the meeting, The trade press rewarded Pirelli with numerous forms of who named Pirelli the “recommended brand” for 2010. recognition in 2010. “Exemplary, with no weaknesses”: For the fifth year in a row, Pirelli won the “Best Tuning this was the brilliant result achieved by the Cinturato P7 Cars & Best Brands 2010” competition, the most popu- in ecologically focused summer tests organised in Ger- lar amongst readers of Auto Illustrierte (AI), a prestig- many by the specialised magazine “Autobild.” These tests ious independent car magazine published in Switzerland. were held to assess the capacity of this type of product to Pirelli was proclaimed the best tyre brand of the year by combine energy savings and safety features, even under over 1,600 readers. the most demanding conditions on wet roads. For the third consecutive year, Pirelli has been rewarded by When compared with four other 205/55R16 V tyres, the the readers of SportAuto, the authoritative German maga- Pirelli “green” tyre designed for medium and high-pow- zine for automotive enthusiasts. In response to the survey ered cars received the highest overall score. It stood out of SportAuto readers, Pirelli was especially appreciated in especially for its performance on wet road surfaces – han- the sportsmanship category, for the score it achieved in the dling and braking distance – and aquaplaning on curves. areas of “stability in curves,” “high-speed safety” and “ex- “Exemplary” was the final judgement of “Autobild,” cellent braking performance.” Pirelli also won in the “emo- which did not find any drawbacks with the Pirelli Cin- tionality” category on the basis of how readers voted in the turato P7, remarking only on “its convincing talent, sat- “I like the brand” and “sport look” areas. isfying energy savings characteristics, smooth driving performance, stable grip on curves and limited braking In 2010, Pirelli also consolidated its collaboration with distances both on dry and wet pavement, and quiet ride.” the Turin Polytechnic as part of a project partly funded by Pirelli passed the 2010 summer tests organised by the the Region of Piedmont, with the development of several German press with brilliant results. Various Pirelli tyre important technologies for the Cyber Tyre, the applica- models topped the test rankings, from the high-perform- tion for several patents to protect the original solutions ance PZero to the reliable Chrono, as well as the Cintu- discovered, and the continuation of projects connected rato family of tyres. with “Next MIRS” and development of a new technol- Pirelli can offer the best products, establishing new stand- ogy based on the production of high-performance com- ards that are recognised by the most prestigious trade pounds (“PTSM”). Various patent applications are being magazines and toughest automobile clubs in Germany. prepared on the basis of this collaboration. The innovations resulting from this joint effort are also In particular: being implemented at the New Industrial Centre in Set- —— PZero won top prize from “AutoZeitung” hands- timo Torinese, one of the most modern and efficient tyre down for its excellent balancing; manufacturing plants in the world. The Group 51

Pirelli’s collaboration with the academic world also in- 500 USA, Volkswagen Touareg, Phaeton and Scirocco. volves the University of Milan - Bicocca. Once again in The new Maserati GranTurismo MC Stradale debuted at the 2010, Pirelli funded research doctorates in the School of Paris Motor Show. This was the first car to be fully equipped Science, through the Corimav (Consorzio ricerca mate- with Pirelli PZero Corsa tyres, which were specifically devel- riali avanzati – advanced materials research consortium). oped and made using the new Next MIRS process. In the car tyre area, Pirelli research and development The new 2011 SMS Mustang 302, from the Signature activity in 2010 turned out new green products like the line designed by Steve Saleen, will be equipped with new, Scorpion Verde, the first high-performance ecological exclusive Pirelli PZero tyres. tyre for SUV and crossover vehicles realised as part of the Another example of avant-garde technology and design corporate Green Performance strategy. is represented by Pagani custom-made cars, which have set two records on the Nürburgring track. In partnership Pirelli maintains close relationships with many of the with Pirelli, the Pagani Zonda R set the new record on the world’s leading carmakers, for the purpose of supplying Nordschleife circuit at Nürburgring, covering 20.83 km in original equipment tyres. They are also fundamental to 6’47” with Pirelli PZero Slick tyres (in the 265/645-19TL, the development of new products and implementation of 325/705-20TL sizes). This time was made possible by the new technologies. excellent road holding characteristics and ability of Pirelli PZero Slick tyres to transfer all of the car’s power to the In 2010, Pirelli received the following final approval for ground. The tyres themselves were fabricated in Milan on use as original equipment on the following makes of car, the first prototype Next MIRS line, which represents the among others: Maserati GranTurismo MC Stradale, state of the art of Pirelli technology dedicated to the manu- Lamborghini New Murcielago, McLaren MP4-12C, Por- facture of ultra-high performance and motorsport tyres. sche Cayenne, Aston Martin One-77, BMW M3 and X3, In 2010 Pirelli Tyre’s research and development efforts Daimler GLK and CLS, Audi A8 and A7, Chrysler-Fiat produced important results on the race track, which are 52 Annual Financial Report at December 31, 2010 Volume 1

the de facto testing grounds on the basis of Superbike championship experience. The for new technological so- tyre contact area was maximised using ICS (Integrated lutions under conditions Contour Shaping) design, which enhances motorcycle where vehicles are pushed to road hold and power output and guarantees unprece- their limits. dented results in terms of stability, performance on wet Pirelli will supply the tyres of surfaces and safety on curves. the Formula 1 World Cham- In April 150 motorcycle racers met at the Zolder track in pionship during the three- Belgium, after being invited by Metzeler to test the new year period 2011-2013. The Sportec M5 Interact. In October the Feelfree Wintec tyre FIA (Fédération Interna- was presented to the international press at the Pirelli test tionale de l’Automobile), the track at Vizzola Ticino. This is the first tyre designed for teams, represented by FOTA using scooters on wet or slippery roads, typical in autumn (Formula One Team Asso- and winter, while guaranteeing safety and reliability. ciation), and the Formula 1 Scorpion Trail, an innovative set of enduro street radial organisation, represented by tyre measurement, was introduced. This was the first of Pirelli Diablo Rosso II FOM (Formula One Man- its kind and created on the basis of the long, close col- agement), chose Pirelli as laboration between Pirelli and Ducati, which has used their exclusive supplier, after Pirelli tyres as original equipment on all its models since approving the solutions pro- January 1, 2010. posed by the Italian Group to guarantee technological In addition to the activities connected with its core Tyre and qualitative continuity to business, the Group has also invested in brand support the racing teams. activities, like PZero. Solutions have been studied even in the apparel sector, to improve shoe comfort and perform- Pirelli has also been engaged ance while following fashion trends. All materials used as exclusive supplier to the have been classified to establish a correlation between GP2 Series World Champi- material characteristics and product performance. onship for the three-year pe- Testing procedures have also been implemented at PZero riod 2011-2013. suppliers to monitor compliance with REACH regulatory The Formula 1 supply agree- requirements governing the potential toxicity of any ma- ment crowns the long-stand- terials we supply. Scorpion Verde ing commitment of Pirelli to car racing, dating back to In the photovoltaic sector, work continued on the design 1907, when the Italian Group and construction of prototype solar trackers for conven- won the Peking-Paris Raid. tional photovoltaic modules. The complete prototypes, Pirelli is currently the exclusive supplier to the world’s which feature innovative designs and large dimensions, most important car and motorcycle races, such as the have a total capacity of about 4 kWp and guarantee up GP3 World Championship, the WRC World Rally Cham- to 40% more energy output than fixed modules and the pionship, the Rolex Sports Car Series in North America, photovoltaic solar concentration project, which guaran- the Superbike World Championship and the Motocross tees extremely high performance in terms of efficiency, in World Championship. It is also involved in over 70 other addition to the possibility of major reductions in compo- national and international championships. nent and process costs.

The Motorcycle business unit launched the new Super- sport Diablo Rosso motorcycle tyre in 2010. Diablo Ros- so II is characterised by the new tread pattern designed using the FGD (Functional Groove Design) technology, which enhances regular wear and tear and further increases the contact surface. To improve road hold, Pirelli used the Enhanced Patch Technology (EPT) developed The Group 53

SIGNIFICANT EVENTS RISKS AND UNCERTAINTIES SUBSEQUENT TO The current macroeconomic situation, financial market THE END OF THE YEAR volatility, complex management processes and continuous legislative and regulatory evolution force successful On January 13, 2011 Pirelli & C. S.p.A. sold its equity businesses to renew their ability to protect and maximise investment in CyOptics Inc. (34.41% shareholding) for tangible and intangible sources of value that characterise USD 23.5 million. their own business model. Assessing and preventing risks that might compromise the Group’s values and objec- On February 10, 2011 Pirelli & C. S.p.A. successfully tives have always been an integral part of Pirelli’s distinc- concluded its placement of an unrated bond issue worth tive spirit of innovation and professional excellence. For a nominal euro 500 million with international insti- these reasons, the Board of Directors decided in tutional investors on the Eurobond market. 2009 to upgrade its corporate governance This issue was enthusiastically received by system by introducing a pro-active risk investors, with requests totalling more management system. It uses a sys- than euro 4.5 billion, or over nine tematic and organised process of times the amount offered. More This issue identifying, analysing and assess- than 93% of the bond issue was ing risk-prone areas that could placed with foreign investors. The was enthusiastically compromise the attainment of placement, executed in accord- received by investors, strategic objectives, provides ance with the Pirelli & C. S.p.A. with requests totalling the Board of Directors and top Board of Directors resolution of management with decision- July 29, 2010, is one of the actions more than euro 4.5 billion, making tools so that they can being taken to streamline the or over nine times anticipate and manage the ef- Group debt structure by lengthen- fects of these risks and, more in ing the average duration of debt and the amount offered general, govern them, guided by diversifying funding sources. the awareness that the assumption The notes have the following character- of risk is a fundamental part of busi- istics: ness management. —— issuer: Pirelli & C. S.p.A. Reference is made to the Corporate Gov- —— guarantor: Pirelli Tyre S.p.A. ernance Report for details on the new risk man- —— amount: euro 500 million agement system. —— settlement date: February 22, 2011 The principal types of risk to which the Group may be —— maturity: February 22, 2016 exposed are listed as follows: —— coupon: 5.125% —— Strategic risks, which are closely tied to the —— issue price: 99.626% Group’s objectives and consequent strategic choices. —— redemption price: 100% This category includes the exogenous risks stem- —— minimum denomination: euro 100 thousand and ad- ming from evolution in the external context where ditional multiples of euro 1000 the Group operates and the risks stemming from in- The effective yield at maturity is 5.212%, correspond- ternal factors, such as financial risks, the risks con- ing to a yield of 230 basis points above the correspond- nected with typical business processes and human ing reference rate (mid swap). The notes will be listed resource/organisation risks; on the Luxembourg Stock Exchange. The placement —— Cross business risks, which can always affect op- was handled by Barclays Capital, acting as global coordi- erating activities regardless of current strategies. This nator, Banca IMI, Mediobanca, SG CIB and Unicredit category includes business interruption risks, infor- as joint bookrunners. mation system risks and financial disclosure risks (in regard to the latter, see the section “Risk Manage- ment System” in the Corporate Governance Report). 54 Annual Financial Report at December 31, 2010 Volume 1

1. STRATEGIC RISKS Country risk

EXTERNAL RISKS The Pirelli Group operates in countries such as Argenti- na, Brazil, China, Egypt, Turkey and Venezuela, where the General economic risks general political and economic context and tax systems might prove unstable in future. The Tyre segment has expanded steadily over the past The risks generally connected with these areas may be decade, and the contraction that occurred during the glo- associated with: bal economic crisis between 2008 and 2009 was turned —— changes in local economic and political conditions; around in 2010. Driven in part by demand from rapidly —— implementation of import and/or export restrictions; developing economies (RDE), the total number of cars —— changes in tax law; on the road worldwide is constantly growing. Even higher —— introduction of policies restricting foreign invest- growth rates have been observed in the segment of cars ment and/or trade, as well as currency control poli- equipped with Premium tyres. These types of tyres are no cies and associated restrictions on the repatriation longer associated strictly with performance and luxury, but of capital; with products that are increasingly linked with sustainabil- —— introduction of more restrictive laws or regulations. ity and safety aspects, areas effectively covered by Pirelli The occurrence of political or economic instability in with its cutting-edge know-how and technology. these areas might impact the Group’s earnings and/or fi- However, due to the difficulty of predicting the magnitude nancial position. and duration of business cycles, Pirelli cannot give any as- surance as to future demand and supply trends for Group FINANCIAL RISKS products sold on the markets where it operates. As also reported in the notes to the consolidated financial In this regard, realisation of the strategic plan might run statements, the Group is exposed to financial risks. These the risk of slower recovery in economic and productive ac- are principally associated with fluctuations in foreign ex- tivity, especially in Western markets, with the consequent change rates, raising funds on the market, fluctuations in possibility of lower than expected turnover for the sector. interest rates, and the ability of customers to honour their In addition, the level of competition on markets where the obligations to the Group. Group operates has increased over the last several years, Financial risk management is an integral part of Group especially in Europe and Latin America, partly due to the business management and is handled directly by head- entry of new, low-cost producers from Asian countries. Fi- quarters in accordance with guidelines issued by the nally, Group profitability might be slightly reduced if the Finance Department on the basis of general risk man- upward trend for raw material prices (especially for raw agement strategies defined by the Managerial Risk Com- rubber) witnessed over the last several months continues mittee. These guidelines define the risk categories and through 2011 and if the Group is unable to counteract this specify the applicable operating procedures and limits for tendency with changes to the commercial price/mix com- each type of transaction and/or instrument. ponent and internal cost efficiency measures.

On the other hand, Tyre segment revenue is based principally on sales volumes that are only partially affected by negative business cycles. Sales are actually heavily driven Exchange rate risk by the spare parts segment, which now accounts for about 75% of revenue, leaving the Group more flexible and less The varied geographical distribution of Pirelli production exposed to any slowdown in the automotive sector and de- and commercial activities entails exposure to transaction mand in the original equipment segment. About 50% of and translation exchange rate risk. Pirelli sales are now made outside of Western markets, and this simple fact, combined with execution of a joint ven- a) Transaction exchange rate risk ture agreement for local production on the Russian market mitigates the Group’s exposure to slowdowns on Western This risk is generated by the commercial and financial trans- markets. Finally, the Group’s preeminent position in the actions executed in currencies other than the functional cur- Premium segment, constant innovation of its product line, rency due to exchange rate fluctuations between the time a complete line of “green” tyres (which now represent 37% when the commercial or financial relationship is established of turnover) and brand enhancement following the supply and when the transaction is completed (collection or pay- agreement made with Formula 1 are all powerful factors ment). that differentiate Pirelli products from those of its low-cost The Group aims to minimise the impact of transaction ex- competitors and help support sales prices. change rate risk on income statement. To do so, internal pro- The Group 55

cedures make the operating units responsible for collecting operates, the Group prefers flexibility in sourcing funds, complete information about the assets and liabilities that are resorting to committed credit facilities. subject to transaction exchange rate risk. This risk is hedged Accordingly, a new five-year revolving credit facility for with futures contracts made with the Group Treasury. euro 1.2 billion was obtained in November 2010. This The items subject to exchange rate risk are mainly rep- new facility will replace existing credit facilities totalling resented by receivables and payables denominated in euro 1.475 billion that were obtained in 2005 and 2007, foreign currency. fall due in 2011 and 2012, and will consequently be can- The Group Treasury is responsible for measuring and man- celled prematurely. Furthermore, the placement of an un- aging the net position for each currency. In accordance with rated bond issue for euro 500 million with international established guidelines and restrictions, it closes all risk posi- institutional investors on the Eurobond market was suc- tions by trading derivative hedging contracts on the market, cessfully completed in February 2011. which typically take the form of futures contracts. The Group has implemented a cash pooling system for Furthermore, as part of the annual and three-year plan- the management of collection and payment flows in com- ning process, the Group makes exchange rate forecasts pliance with various local currency and tax laws. Banking according to these time horizons by using the best in- relationships are negotiated and managed centrally, in or- formation available on the market. The fluctuation in ex- der to ensure coverage of short and medium-term finan- change rates between the time when the forecast is made cial needs at the lowest possible cost. The procurement of and the time when the commercial or financial transac- medium and long-term resources on the capital market is tion is established represents the transaction exchange also streamlined through centralised management. rate risk on future transactions. In accordance with established policy, the Group monitors the opportunity to hedge future transactions, with each Interest rate risk hedge being authorised by the Finance Department on a case-by-case basis. Fluctuations in interest rates impact the market value of Group financial assets and liabilities and net financial ex- b) Currency translation risk penses. Group policy is to attempt to maintain the following ratio Pirelli owns controlling interests in companies that pre- between fixed rate and variable rate exposures: 65% fixed pare their financial statements in currencies other than and 35% variable. the euro, which is the Group presentation currency. This The Group makes derivative contracts, typically interest exposes the Group to currency translation risk, which is rate swaps that are authorised by the Finance Department generated by the conversion of assets and liabilities of in order to maintain this target ratio. those subsidiaries into euro. The principal exposures to currency translation risk are mon- Price risk associated with financial assets itored, but the Group has no policy to hedge this exposure. Group exposure to price risk is limited to the volatility of financial assets, such as listed and unlisted stocks and Liquidity risk bonds, which represent 7.1% of total Group assets.

The principal instruments used by the Group to man- Credit risk age the risk of having insufficient resources to meet its financial and commercial obligations according to agreed Credit risk represents Group exposure to contingent terms and due dates are comprised by its annual and losses resulting from default by commercial and financial three-year cash-pooling plans. These allow complete and counterparties. fair detection and measurement of incoming and outgo- To limit commercial counterparty default risk, the ing cash flows. The differences between the plans and the Group has implemented procedures to evaluate its cus- final balances are constantly analysed. tomers’ potential and financial solidity, monitor expect- Prudent management of the risk described above requires ed incoming cash flows and take credit recovery action maintaining an adequate level of cash equivalents and/or if necessary. highly liquid short-term financial instruments, the avail- The aim of these procedures is to define customer ability of funds through an adequate amount of commit- credit limits. Further sales are suspended when those ted credit facilities, recourse to the capital market and/or limits are exceeded. the ability to close outstanding positions on the market. In certain cases customers are asked to provide guaran- Due to the dynamic nature of the business in which it tees. These mainly consist of standby letters of credit is- 56 Annual Financial Report at December 31, 2010 Volume 1

sued by parties with excellent credit or personal standing. ard of objective business liability that has also been re- Less frequently, mortgage guarantees may be requested. ceived in Italian law (Legislative Decree 231/01). Refer- ence is made to the Sustainability Report for details on Insurance policies are another instrument used to man- the process of managing and controlling these risks. age commercial credit risk. These policies aim to prevent the risk of non-payment through careful selection of cov- Product defect risk ered customers in collaboration with the insurance company, which undertakes to indemnify the Group in the Pirelli might be affected by product liability suits or by event of customer insolvency. product recalls due to presumed defects in sold materi- The Group deals only with highly rated financial coun- als. Although no major events of this sort have occurred terparties for the management of temporary surplus cash in recent years and notwithstanding insurance coverage or for trading in derivatives. against these risks, the Pirelli brand might be negatively The Group does not have significant concentrations of impacted should they ever occur. credit risk. Litigation risks RISKS ASSOCIATED WITH ORDINARY PROCESSES In the course of operating its business, Pirelli might be involved in legal actions, tax litigation, commercial lawsuits Environmental risks or labour lawsuits. The Group takes all measures necessary to prevent and attenuate any penalties that might The activities and products of the Pirelli Group, a mul- result from these proceedings, including the accrual of tinational that does business worldwide, are subject to provisions for liabilities detailed in the Explanatory Notes numerous environmental laws that vary from country to to the Consolidated Financial Statements (note 22). country. In any case, these laws share a common tendency to become increasingly restrictive over time, partly in RISKS ASSOCIATED WITH HUMAN RESOURCES response to the growing commitment by the international community to environmental sustainability. The Group is exposed to the loss of human resources It is likely that stricter laws will be gradually introduced, holding key positions or possessing critical know-how, regulating the various types of environmental impact which might have a negative impact on future results. To that businesses might have (air pollution, waste output, face this risk, Pirelli has adopted bonus policies that are soil contamination, water use, etc.). Consequently, the periodically revised according to general macroeconomic Pirelli Group expects that it will have to continue to in- conditions, among other factors. Moreover, in the vari- vest and/or incurring costs for what might become sig- ous countries where the Group operates, its employees nificant amounts. are protected by laws and/or collective agreements that Reference is made to the Sustainability Report chapter guarantee them the right to be consulted through local “Environmental Dimension” for details on the process and national representatives in regard to specific organi- of managing and controlling environmental risks de- sational or industrial issues, including downsizing or the scribed above. closure of departments and staff redundancies.

Employee health and safety risks 2. CROSS BUSINESS RISKS As part of operating its business, the Pirelli Group bears liabilities and costs for the measures necessary to guaran- RISKS ASSOCIATED WITH INFORMATION tee full compliance with its obligations under workplace SYSTEMS AND NETWORK INFRASTRUCTURE health and safety protection laws. Specifically in Italy, the workplace health and safety law (Legislative Decree Group operating activities rely increasingly on the proper, 81/08), as amended (Legislative Decree 106/09), has in- uninterrupted functioning of information systems and net- troduced new obligations impacting the management of work infrastructure in support of business processes. The activities at Pirelli sites and the systems for allocating re- complexity of the information system environment used, sponsibility. Failure to comply with applicable laws and the distribution of activities worldwide and links between regulations results in the imposition of criminal and/or them may increase the level of risks connected with infor- civil penalties on the persons responsible and, in certain mation and communication technology. Human error, access cases where health and safety laws are violated, on the by unauthorised persons, vulnerable security systems, and firms themselves, in accordance with a European stand- system breakdowns or malfunctions might impact the per- The Group 57

formance of operating activities and cause the disclosure BUSINESS OUTLOOK of critical, confidential corporate information, with consequent repercussions on the Group’s corporate image, On the basis of the strategic guidelines set out in the financial losses, competitive disadvantages and the risk of 2011-2013 Business Plan and in response to the contin- statutory and regulatory violations. To manage and control ued growth in demand, in 2011 the Company will focus these risks, the Group has taken appropriate measures to more and more on the development of Premium prod- protect its business operations and the confidentiality of ucts and expansion of its production capacity, mainly in corporate information. rapidly developing economies. In the absence of currently unforeseeable events and con- BUSINESS INTERRUPTION RISKS sidering that raw material prices are rising faster than assumed in the The global scale of Group operations Business Plan presented last No- exposes it to a plethora of risks that vember, price increases will be might even cause an interruption in In 2011 the Company greater than originally assumed. business activities for an indefinite will focus more and more on Consequently, the 2011 target period of time, consequently im- for Group sales, 99% of which pacting its operating and financial the development of Premium are accounted for by Pirelli results. products and expansion of its Tyre, is now being increased Risks associated with natural or production capacity, mainly from “over euro 5.15 billion” accidental events (fire, flood, earth- in rapidly developing to “over euro 5.55 billion.” quake, etc.), malicious acts (terror- This reflects expected growth in ism, sabotage, etc.), malfunctions in economies. the volume component of 6% or auxiliary plants or interruption of utili- more (+ 4% was the previous es- ties (e.g. power supply) may cause seri- timate) and about 12% in the price/ ous damage and production losses, with a mix component (+ 4% was the previ- particular impact on production sites that have ous estimate). The target ROS is expected high volumes or specific products. to grow from 2010 as forecast in the Business Plan Other risks might also result from the unavailability of in- (8.5%-9.5% for the Group and 9%-10% for Pirelli Tyre), formation systems essential to production activities and due to continuation of the cost efficiency recovery pro- the interruption of telecommunication links between the gramme. Plans forecast euro 500 million in capital ex- various Group sites. These risks are monitored and man- penditure in 2011. Net financial position is expected to aged both with preventive measures and insurance, and rise negative to about euro 700 million. with response procedures and measures to manage emer- gencies and restore operations. 58 Annual Financial Report at December 31, 2010 Volume 1 pirelli tyre Pirelli Tyre 59

SELECTED ECONOMIC AND FINANCIAL DATA The consolidated results for 2010 as compared with those for 2009 are highlighted in the following table:

(in millions of euro) 12/31/2010 12/31/2009 Net sales 4,772.0 3,992.9 Gross operating profit before restructuring expenses 684.3 538.0 % of net sales 14.3% 13.5% Operating income before restructuring expenses 476.3 345.5 % of net sales 10.0% 8.7% Restructuring expenses (23.2) (37.0) Operating income 453.1 308.5 % of net sales 9.5% 7.7% Net income (loss) from equity investments 0.3 4.2 Financial income/(expenses) (66.4) (76.1) Income tax (134.4) (90.0) Net income (loss) 252.6 146.6 % of net sales 5.3% 3.7%

Net financial (liquidity)/debt position 1,109.9 1,027.3 Net operating cash flow 168 395 Capital expenditure 402 217 Research and development expenses 146 133 % of net sales 3.1% 3.3% Employees (number at end of period) 28,865 27,481 Industrial sites (number) 19 20

Net sales in 2010 totalled euro 4,772.0 million, up 19.5% Sales in Q4 2010 confirmed their positive performance from the previous year. Sales grew in both business seg- compared to the same period of 2009, continuing the ments, with the consumer segment rising by 16.7% and trend established during the preceding quarters, with a the industrial segment by 26.3%. total increase of 17.3% (+14.7%). The price/mix component weighed heavily in Q4 2010, just as in the previous The like-for-like change, excluding the effect of exchange quarter, with a positive change of 11.3%, while volume rate fluctuations, was an increase of 16.2%. increased by 3.4%. Growth was driven by the positive contribution made by all components, with volume up by 7.3% and the prod- Sales grew in both business segments, with the consumer seg- uct/mix component up by 8.9%. The exchange rate effect ment rising by 16.2% and the industrial segment by 19.7%. was a positive 3.3%. The following table summarises the individual components of changes in sales during 2010, detailing the trend for each quarter:

Q1 Q2 Q3 Q4 Total 2010 2009 2010 2009 2010 2009 2010 2009 2010 2009 Volumes 17.4% -18.1% 7.5% -13.3% 1.8% -3.3% 3.4% 15.6% 7.3% -5.8% Prices/Mix 1.4% 6.9% 10.1% 5.6% 12.3% 4.7% 11.3% -1.7% 8.9% 4.2% Change on a like-for-like basis 18.8% -11.2% 17.6% -7.7% 14.1% 1.4% 14.7% 13.9% 16.2% -1.6% Foreign exchange effect 1.0% -2.7% 5.3% -1.5% 4.2% -3.3% 2.6% 4.8% 3.3% -1.0% Total change 19.8% -13.9% 22.9% -9.2% 18.3% -1.9% 17.3% 18.7% 19.5% -2.6% 60 Annual Financial Report at December 31, 2010 Volume 1

The distribution of net sales by geographical area and product category is set forth as follows:

GEOGRAPHICAL AREA 2010 2009 euro/mln ∆ yoy Italy 9% 409,0 11% 9% Rest of Europe 31% 1,503.5 13% 33% Nafta 10% 477.4 32% 9% Central and South America 34% 1,632.1 26% 33% Asia/Pacific 6% 286.9 24% 6% Middle East/Africa 10% 463.1 13% 10% Total 100% 4,772.0 20% 100%

PRODUCT CATEGORY 2010 2009 euro/mln ∆ yoy Car tyres 62% 2,938.6 17% 63% Motovelo tyres 8% 361.7 15% 8% Consumer 70% 3,300.3 17% 71%

Industrial vehicle tyres 28% 1,364,2 26% 27% Steelcord 2% 107.5 25% 2% Industrial 30% 1,471.7 26% 29%

Sales grew in all geographical areas in absolute terms, The following table shows the changes in operating while the weight of NAFTA area increased, partially due income for 2010 on a quarter-by-quarter and cumula- to the positive average performance of the benchmark tive basis in comparison with the same periods of the currency (USD) against the euro as compared with 2009. previous year:

(in millions of euro) Q1 Q2 Q3 Q4 Cumulative 2010 2009 2010 2009 2010 2009 2010 2009 2010 2009 Net sales 1,110.0 926.9 1,215.3 989.0 1,233.8 1,042.7 1,212.9 1,034.3 4,772.0 3,992.9 Δ yoy 19.8% -13.9% 22.9% -9.2% 18.3% -1.9% 17.3% 18.7% 19.5% -2.6% Gross operating profit before restructuring expenses 146.4 107.8 177.5 133.0 173.0 142.0 187.4 155.2 684.3 538.0 % of sales 13.2% 11.6% 14.6% 13.4% 14.0% 13.6% 15.5% 15.0% 14.3% 13.5% Operating income before restructuring expenses 98.1 61.0 127.1 85.5 121.5 94.3 129.6 104.7 476.3 345.5 % of sales 8.8% 6.6% 10.5% 8.6% 9.8% 9.0% 10.7% 10.1% 10.0% 8.7% Operating income 95.5 57.5 121.8 79.3 117.0 85.9 118.8 85.8 453.1 308.5 % of sales 8.6% 6.2% 10.0% 8.0% 9.5% 8.2% 9.8% 8.3% 9.5% 7.7%

Just as in all preceding quarters of the year, operating es reached euro 129.6 million (10.7% of sales), com- income in Q4 2010 was up from the same period of pared with euro 104.7 million in the same period of 2009, and specifically: 2009 (10.1% of sales). —— gross operating profit before restructuring expenses was euro 187.4 million (15.5% of sales), up Again in Q4 2010, the effects of growing sales volumes 21% from the same period of 2009 (euro 155.2 mil- and continuous action on the price/mix component, lion, or 15.0% of sales); combined with cost efficiency measures, effectively off- —— operating income before restructuring expens- set rising input costs, especially for raw materials. Pirelli Tyre 61

4,772 million

net sales 62 Annual Financial Report at December 31, 2010 Volume 1

Throughout all 2010, gross operating profit before sales). The growth in return on sales is particularly sig- restructuring expenses was euro 684.3 million (14.3% nificant, notwithstanding a significant increase in raw of sales), up euro 146.3 million (+27%) from 2009, when material costs (which totalled euro 270 million for the it totalled euro 538.0 million (13.5% of sales). year, and euro 125 million in the fourth quarter alone), achieved through the previously mentioned actions on Operating income before restructuring expenses the price/mix component and cost efficiency gains. in 2010 totalled euro 476.3 million (10.0% of sales), The change in operating income before restructuring up euro 130.8 million compared to the same period expenses during 2010 from the previous year is sum- of 2009, when it totalled euro 345.5 million (8.7% of marised as follows:

(in millions of euro) Q1 Q2 Q3 Q4 Cumulative 2009 operating income before restructuring expenses 61.0 85.5 94.3 104.7 345.5 Foreign exchange effect (5.2) 2.2 2.7 3.5 3.2 Prices/mix 6.1 86.6 107.3 131.9 331.9 Volumes 50.8 25.2 5.2 19.8 101.0 Cost of production factors (raw materials) (6.7) (62.1) (76.4) (125.1) (270.3) Cost of production factors (labour/energy/others) (7.4) (12.8) (14.7) (12.6) (47.5) Efficiency gains 7.6 5.3 14.4 22.8 50.1 Amortisation. depreciation and other (8.1) (2.8) (11.3) (15.4) (37.6) Change 37.1 41.6 27.2 24.9 130.8 2010 operating income before restructuring expenses 98.1 127.1 121.5 129.6 476.3

Operating income for 2010 was euro 453.1 million, Net income for 2010 totalled euro 252.6 million (af- up from 2009, when it totalled euro 308.5 million, with ter total financial expenses of euro 66.1 million and ROS (return on sales) of 9.5%. These results topped income taxes of euro 134.4 million, with a tax rate of even the latest forecasts for 2010. 34.7%). This compares to net income of euro 146.6 Restructuring measures continued in 2010. Focused million in previous year (after total financial expenses on the European area, they aimed to improve the over- of euro 71.9 million and income taxes of euro 90.0 mil- all Group cost structure by euro 23.2 million. lion, with a tax rate of 38.0%).

Settimo Torinese’s project disegned by Renzo Piano Pirelli Tyre 63

Net financial position is negative and totalled euro at December 31, 2009. This figure is euro 95.1 million 1,109.9 million, after paying dividends of euro 226.6 lower than in September 2010. million to the Parent company, in comparison with a negative net financial position of euro 1,027.3 million The change may be summarised as follows:

(in millions of euro) Q1 2010 Q2 2010 Q3 2010 Q4 2010 2010 2009 Operating income (EBIT) before restructuring expenses 98.1 127.1 121.5 129.6 476.3 345.5 Amortisation and depreciation 48.3 50.4 51.5 57.8 208.0 192.5 Purchase of property. plant and equipment and intangible assets (47.6) (84.5) (88.1) (184.8) (405.0) (217.4) Change in working capital/other (132.2) 37.0 (9.9) 194.3 89.2 240.9 Operating cash flow (33.4) 130.0 75.0 196.9 368.5 561.5 Financial expenses/tax charges (45.6) (61.7) (50.8) (42.7) (200.8) (166.1) Net operating cash flow (79.0) 68.3 24.2 154.2 167.7 395.4 Dividends paid to non-controlling interests - (3.8) - - (3.8) (2.3) Purchase of non-controlling interests in Turkey and disposal of assets - - - - - 11.0 Cash out for restructuring expenses (22.2) (8.3) (7.0) (2.0) (39.5) (62.4) Foreign exchange differences/other 6.0 9.4 (9.3) 13.5 19.6 (38.0) Net cash flow before dividend payment to parent (95.2) 65.6 7.9 165.7 144.0 303.7 Dividends paid to parent (156.0) - (70.6) (226.6) (64.2) Net cash flow (95.2) (90.4) 7.9 95.1 (82.6) 239.5

Net operating cash flow for the year was positive for euro and in China for the production of radial motorcycle tyres. 167.7 million (positive for euro 154.2 million in the last Other capital expenditure targeted the Group’s remaining quarter), despite the significant increase in capital ex- production sites, to increase the product mix, launch new penditure that was almost double of depreciation. This was “Green Performance” products, and make improvements to achieved on the good earnings performance and constant employee health and safety conditions and environmental focus on efficient management of working capital. management of factories. When broken down by business segment, 77% In the last quarter, working capital contrib- of capex targeted activities in the con- uted euro 194.3 million to the Group’s sumer segment and improvement in cash position, partly reflecting the production capacity in Romania, seasonal variation in sales receipts China and Brazil, growth in the for the Winter product in Europe, A new Settimo high-end segment in Europe, and and made a positive contribution Torinese production completion of the new Techno- to cash flow overall despite the in- logical Centre at Settimo Tori- crease in activity. centre, which is destined nese with construction of the Net cash flow for the year, be- to become the Group’s new, innovative “Next MIRS” fore dividends paid to the par- most technologically process line for the production ent, totalled a positive euro of high-end tyres. 144.0 million. advanced production The remaining 23% was tar- site in the world geted at supporting activities in Capital expenditure totalled euro the industrial segment, focused 402 million, up sharply from 2009, on consolidating production growth when it totalled euro 217 million. Seven- in South America, Egypt and Turkey, ty per cent of capex was focused on growth while installation continued on machin- projects undertaken in Italy (with completion of ery used to manufacture products with SATT construction on the new Settimo Torinese production cen- (Spiral Advanced Technology for Trucks), derived from tre, which is destined to become the Group’s most tech- MIRS technology. nologically advanced production site in the world), South At December 31, 2010, installed production capacity America, Romania and China. Construction also began on was about 56.0 million units in the consumer segment new plants in Mexico for the production of Vettura tyres and about 5.8 million units in the industrial segment. 64 Annual Financial Report at December 31, 2010 Volume 1

Total headcount at December 31, 2010 was 28,865 mainly due to growth in activity in South America, Roma- employees, including 2,301 temporary workers and 119 nia and China. agency workers. Headcount rose by a total of 1,384 employees from De- At December 31, 2010, the workforce (excluding employ- cember 31, 2009, including 1,300 blue collar workers, ees with temporary contracts) is broken down as follows:

2010 2009 Executives 1.0% 0.9% White collar 18.8% 19.3% Blue collar 80.2% 79.8% 100.0% 100.0%

CONSUMER BUSINESS

The table below shows 2010 operating results broken down on a quarterly basis, the total for all of 2010, and comparisons with the same periods of 2009:

(in millions of euro) Q1 Q2 Q3 Q4 Cumulative 2010 2009 2010 2009 2010 2009 2010 2009 2010 2009 Net sales 780.9 670.5 835.8 701.5 847.1 736.0 836.5 719.8 3,300.3 2,827.8 Δ yoy 16.5% -10.4% 19.1% -6.0% 15.1% 3.1% 16.2% 21.3% 16.7% 0.9% Gross operating profit before restructuring expenses 106.0 77.4 122.4 90.4 118.9 100.4 141.1 111.5 488.4 379.7 % of sales 13.6% 11.5% 14.6% 12.9% 14.0% 13.6% 16.9% 15.5% 14.8% 13.4% Operating income before restructuring expenses 69.5 41.9 84.7 54.5 80.5 64.1 99.9 73.2 334.6 233.7 % of sales 8.9% 6.2% 10.1% 7.8% 9.5% 8.7% 11.9% 10.2% 10.1% 8.3% Operating income 67.0 39.9 80.3 51.0 77.2 59.2 92.5 59.7 317.0 209.8 % of sales 8.6% 6.0% 9.6% 7.3% 9.1% 8.0% 11.1% 8.3% 9.6% 7.4%

Net sales in 2010 totalled euro 3,300.3 million, up In regard to sales, the positive structural change in Q4 16.7% from 2009. On homogeneous basis and excluding 2010 (+13.5%) was driven both by a 4.2% increase in the exchange rate effect, the change was +14.0%, attrib- volumes and continuous use of the price/mix component, utable for 6.4% to the volume component and 7.6% to which contributed 9.3% to growth. the price/mix component. Gross operating profit be- These were the elements that, together with the positive fore restructuring expenses totalled euro 488.4 mil- effects of efficiency measures, substantially made it pos- lion, or 14.8% of sales (+29% from 2009). Operating sible to increase profitability during the fourth quarter, in income before restructuring expenses reached euro spite of cost pressures due to higher raw materials prices. 334.6 million (10.1% of sales), in comparison with euro Turning to the performance of the Group’s various target 233.7 million generated in 2009 (8.3% of sales). Oper- markets, the Original Equipment segment expanded ating income grew by 51% from the previous year, to in 2010, with growth rates ranging from +13% in Europe euro 317.0 million (with ROS of 9.6%), compared with (+5% in the fourth quarter), +39% in NAFTA (+6% euro 209.8 million in 2009 (ROS of 7.4%). in the fourth quarter) and +13% in the Mercosur area In Q4 2010 net sales totalled euro 836.5 million (+16.2% (+6% in the fourth quarter). from the same period of 2009), with profitability up both in absolute terms (operating income before restruc- In comparison with 2009, the Replacement segment turing expenses of euro 99.9 million, compared with posted higher growth rates in all areas, with +8% in Eu- euro 73.2 million) and in percentage terms, with a return rope (+7% in the fourth quarter), +4% in NAFTA (with on sales of 11.9% (10.2% in the same period of 2009). +1% in the fourth quarter), and +11% in the Mercosur Pirelli Tyre 65

area (+4% in the fourth quarter). In 2010, Pirelli made three-year supply contract, special mention should be 75% of its sales in the Replacement segment and 25% in made of the excellent performance of tyres supplied to all the Original Equipment segment. WRC teams. For example, just 0.15% of the 27,995 tyres used over three seasons suffered a puncture. The Winter market continued expanding in Europe dur- Pirelli also reconfirmed its leading position in European ing 2010 (+21%), with a low level of stock on the distri- rallies, triumphing in the Italian, Swiss, Austrian, Portu- bution network at year end. guese, Greek and Turkish championships. Other major successes were achieved in the Chinese, Lebanese and In the Car business, which accounts for 89% of segment Ukrainian championships. Pirelli remained the exclusive turnover, net sales soared by 17% from 2009, while the supplier to the British Rally Championship, the Swed- Motorcycle business, which accounts for 11% of the ish Rally Championship, the Finnish Rally Champion- segment, climbed by 15% overall. ship, the Argentine Rally Championship and the South American Codasur Rally Championship. The Group also In 2010, the Pirelli Motorsport Car business won the participates as partner of various Italian car makers, sup- prestigious distinction of being named exclusive supplier plying racing tyres to their single-brand championships. to the Formula One Championship for the three-year pe- Finally, the Pirelli Star Driver programme for selection riod 2011-2013. of young rally talents worldwide continued: six teams will participate in six European WRC 2011 races at the new During the year, the Group remained the exclusive tyre WRC Academy. supplier to the Rolex Grand Am in the United States and Pirelli continued supplying road racing tyres on an exclu- the World Rally Championship (WRC). At the end of the sive basis to the Ferrari Challenge championships in Italy, 66 Annual Financial Report at December 31, 2010 Volume 1

Europe and the United States, and the Lamborghini Su- Interact and F800 R with the Sportec M5 Interact; Tri- per Trofeo in Europe, and also became exclusive supplier umph Tiger 800 XC with the Karoo and Speed Triple to the Maserati Trofeo championship in 2010. with the Racetec K3. In the FIA-GT series, it continued participating in na- Pirelli enjoyed great success on all racetracks during 2010. tional single-tyre championships (UK GT, Scandinavia Participation as the sole supplier to the World Superbike GT, Portugal GT and Brazil GT). series, with the participation of seven motorcycle makers In the Motorcycle business, Pirelli confirmed its tech- (Aprilia, BMW, Ducati, Honda, Kawasaki, Suzuki and nological leadership in 2010 by obtaining approval for Yamaha), continued to garner Pirelli major visibility in important products, including new tyres launched on the the media. In Motocross, it racked up numerous pres- market during the year. tigious wins, including the Motocross MX1 and MX2 Pirelli brand tyres were introduced for the Ducati Diavel World Championship, the World Rally Championship, with the Diablo Rosso II dual compound; Aprilia RSV4 and Le Touquet Championship. Metzeler reconfirmed its APRC with the Diablo Supercorsa SP in the new WSBK status off road, winning first place at the World Enduro version; KTM all motocross range the Scorpion MX; Tri- Championship in the E2 and E3 classes, and second and umph Tiger 800 with the Scorpion Trail; Honda Cross third place in the E1 class. Runner with the Scorpion Trail. Our participation in road and off-road racing, ranging Metzeler brand tyres were introduced for the Honda from major world championships to local ones, offers the Scooter concept with the Roadtec Z8 Interact and ideal opportunity for developing new solutions and af- SH300 with the Feelfree; BMW K1600 GT with the firming our leadership. Roadtec Z8 Interact, R1200 R/RT with the Roadtec Z8 Pirelli Tyre 67

INDUSTRIAL BUSINESS

The table below shows 2010 operating results broken down on a quarterly basis, the total for all of 2010, and comparisons with the same periods of 2009:

(in millions of euro) Q1 Q2 Q3 Q4 Cumulative 2010 2009 2010 2009 2010 2009 2010 2009 2010 2009 Net sales 329.1 256.4 379.5 287.5 386.7 306.7 376.4 314.5 1,471.7 1,165.1 Δ yoy 28.4% -22.0% 32.0% -16.3% 26.1% -12.2% 19.7% 13.4% 26.3% -10.3% Gross operating profit before restructuring expenses 40.4 30.4 55.1 42.6 54.1 41.7 46.3 43.6 195.9 158.3 % of sales 12.3% 11.9% 14.5% 14.8% 14.0% 13.6% 12.3% 13.9% 13.3% 13.6% Operating income before restructuring expenses 28.6 19.1 42.4 31.0 41.0 30.2 29.7 31.5 141.7 111.8 % of sales 8.7% 7.5% 11.2% 10.8% 10.6% 9.8% 7.9% 10.0% 9.6% 9.6% Operating income 28.5 17.6 41.5 28.3 39.8 26.7 26.3 26.1 136.1 98.7 % of sales 8.7% 6.9% 10.9% 9.8% 10.3% 8.7% 7.0% 8.3% 9.2% 8.5%

Net sales in 2010 totalled euro 1.471.7 million, up Turning to the performance of the Group’s various target 26.3% from 2009. On a like-for-like basis and excluding markets, the Original Equipment segment expanded in the exchange rate effect, the change was +21.7%, attrib- 2010, with growth rates ranging from +57% in Europe utable for 9.4% to the volume component and 12.3% to (+90% in the fourth quarter) and +47% in the Mercosur the price/mix component. Gross operating profit be- area (+22% in the fourth quarter). fore restructuring expenses totalled euro 195.9 million, or 13.3% of sales (+24% from 2009). Operating In comparison with 2009, the Replacement segment income before restructuring expenses reached euro posted higher growth rates in all areas previously high- 141.7 million (9.6% of sales), in comparison with euro lighted in previous quarters, with growth of +23% in the 111.8 million generated in 2009 (9.6% of sales). Oper- Mercosur area (+22% in the fourth quarter) and +18% ating income totalled euro 136.1 million (with ROS of in Europe (+9% in the fourth quarter). 9.2%), up 38% from 2009, when it totalled euro 98.7 million (with ROS of 8.5%). In the Truck business, which represents 81% of the segment, aggregate net sales grew by 25% from 2009. In the In Q4 2010 net sales totalled euro 376.4 million (+19.7% Agro business, which represents 12% of the segment, ag- from the same period of 2009), operating income be- gregate net sales growth was 43%. The Steelcord out- fore restructuring expenses of euro 29.7 million (ROS sourcing business, which represents 7% of the segment, of 7.9%), compared with euro 31.5 million in operating posted aggregate growth of 25%. income before restructuring expenses in the same period of 2009 (ROS of 10.0%). The percentage figure was impacted by the increase in raw material costs, which have a greater impact on this segment particularly in regard to natural rubber. These costs were offset in absolute terms by price increases. The positive structural change in sales during Q4 2010 (+17.3%) was mainly driven by the price/mix component of 15.7%, which offset the cost increases that were largely tied to raw material prices, while the volume component contributed 1.6% to growth. 68 Annual Financial Report at December 31, 2010 Volume 1

OTHER BUSINESSES Other businesses 69

he other businesses are comprised by Pirelli & C. Both Pirelli & C. Eco Technology S.p.A. and Pirelli Eco Technology S.p.A., Pirelli & C. Ambiente & C. Ambiente S.p.A. are 51% owned by Pirelli & C. TS.p.A., PZero S.r.l., and all Group holding and S.p.A. and 49% by Cam Partecipazioni S.p.A., a Cam- service companies, including the Parent, Pirelli & C. S.p.A.. fin Group company.

(in millions of euro) Pirelli Eco Pirelli Ambiente PZero Other Total other Technology businesses 2010 2009 2010 2009 2010 2009 2010 2009 2010 2009 Net sales 61.4 56.6 4.4 3.6 7.7 5.0 2.9 9.4 76.4 74.6 Operating income (12.9) (10.8) (6.3) (3.7) (0.3) (3.8) (25.8) (40.5) (45.3) (58.8) Net income (loss) (14.9) (13.7) (8.2) (5.3) (0.4) (3.9) (1.1) (46.1) (24.6) (69.0) Net financial (liquidity)/debt position 38.0 47.2 30.1 44.0 3.8 3.5 (726.2) (598.8) (654.3) (504.1)

Taken together, these other businesses show an operat- PIRELLI ECO TECHNOLOGY ing loss of euro 45.3 million for the year (including euro 1.5 million in restructuring expenses), compared with This business was impacted by delayed growth in sales an operating loss of euro 58.8 million in 2009 (includ- volumes, partly due to slow definition of applicable regu- ing 18.2 million for restructuring expenses). Aside from latory procedures, and consequent under-utilisation of the performance of the businesses commented on be- the production plant. During the year, 5,128 Feelpure low, non-recurring costs were incurred during the year filter systems were sold (4,677 in December 2009) for a for studies to reorganise the Group and provisions for a total of euro 23.4 million (euro 18.5 million in December lawsuit connected with assets disposed of in the 1990’s. 2009). The operating loss totalled euro 12.9 million. These costs were offset by a real estate gain in Brazil and Full operation also started up at the production plant in sale of the Ceat brand. China, which serves the local market. 70 Annual Financial Report at December 31, 2010 Volume 1 shop at pzeroweb.com

THE GRIP Other businesses 71

PIRELLI AMBIENTE PZERO S.R.L.

This business operates in the environmental sector through Created at the end of 2007, Pzero S.r.l. is the natural evo- its subsidiaries and associates, and is active in the following lution of a licensing and brand extension project launched specific segments: the production of electric power from about ten years ago to exploit the brand equity of Pirelli. photovoltaic panels; environmental clean-up; energy certi- In synergy with Pirelli corporate communication activi- fication; the production of high quality waste-to-fuel. ties, Pzero offers the vehicle for developing the value of In 2010 this business posted an operating loss of euro 6.3 Group brands through major advertising campaigns in million and a net loss of euro 8.2 million. the italian and international media, high exposure in In the photovoltaic panel sector, the subsidiary Solar press reports and the visibility of products sold at high- Utility S.p.A. completed start-up of production at the end retail outlets. plants located in towns of Alessano, Nardò, Vaglio, Tor- In spite of persistent softness in aggregate consumer de- remaggiore and Ugento, with total output of 7 MW. Fol- mand, Pzero S.r.l. continued to grow in 2010. This im- lowing the strategic agreement for joint development of provement is mainly attributable to an increase in shoe activity in the Italian photovoltaic panel sector, signed sales volumes, stemming from improved penetration by on July 15, 2010 between Solar Utility S.p.A. and GWM the brand amongst individual customers and the growing Group Inc., these plants with a combined capacity of 7 number of customers both inside and outside Italy. Out- MW were granted to a new company named GP Energia side Italy, the brand’s principal markets are Spain, Russia S.p.A. The latter was initially 60% owned by GWM Re- and Eastern Europe, Great Britain and China. The best newable Energy S.p.A. and 40% by Solar Utility S.p.A.. growth prospects are represented by China, the United The shareholding in GP Energia S.p.A., which was re- States and South America. duced in September 2010 to 31% due to the disposal of In 2010, the company prepared a two-pronged growth plan. shares, rose to 35% in early 2011 following the grant of The first choice was to apply the same business model additional plant. used for shoes to the apparel lines. Upon expiration of a brand license granted to others, the company decided to take over direct management of apparel production and marketing. The company has also prepared a plan to develop a single-brand retail chain, with the opening of its first store in Milan scheduled within 2011.

72 Annual Financial Report at December 31, 2010 Volume 1

PIRELLI & C. S.P.A.: HIGHLIGHTS Pirelli & C. S.p.A.: Highlights 73

he following table illustrates highlights of the Parent’s main income, balance sheet and finan- Tcial data: (in millions of euro) 12/31/2010 12/31/2009 Operating income (39.6) (39.5) Net financial income and net income from equity investments 229.5 150.9 Net income of continuing operations 191.0 112.6 Net income (loss) of discontinued operations (103.6) - Net income 87.4 112.6 Non-current financial assets 965.2 1,548.5 Equity 1,584.6 1,822.8 Net financial (liquidity)/debt position (597.2) (253.1)

Net financial income and net income from equity in- Broadband Solutions S.p.A.(euro 16.1 million). vestments, totalling euro 229.5 million, principally consist of euro 226.6 million in dividends received from the subsidi- The reduction in non-current financial assets reflects not ary Pirelli Tyre S.p.A., dividends of euro 24.6 million from only the impairments mentioned above, but also the previ- other subsidiaries, impairment of the subsidiary Pirelli UK ously mentioned assignment of the shares held in Pirelli RE Ltd for euro 21.2 million, impairment of the equity invest- (now Prelios) to shareholders for euro 329.6 million, wind- ment in the subsidiary Pirelli & C. Ambiente S.p.A. for euro ing-up of the two Dutch holding companies Pirelli Holding 2.2 million and impairment of the equity investment in RCS N.V. and Sipir Finance N.V. for euro 204.2 million, and the MediaGroup S.p.A. for euro 8.6 million (which now has a previously mentioned sale of Pirelli Broadband Solutions book value of euro 1.48 per share). S.p.A. for euro 26.3 million.

Net income was negatively impacted by the assignment of The following table summarises the carrying values of the former Pirelli RE (now Prelios) shares (euro 119.7 million), principal non-current financial assets at December 31, 2010: which was partly offset by the net gain on disposal of Pirelli

(in millions of euro) 12/31/2010 Equity investments in subsidiaries Pirelli Tyre S.p.A. 585.9 Pirelli Societè Generale S.A. - Switzerland 17.5 Pirelli & C. Eco Technology S.p.A. 16.9 Pirelli Finance (Luxembourg) S.A. - Luxembourg 13.8 Pirelli Ltda - Brazil 9.7 Pirelli & C. Ambiente S.p.A. 3.6 Pirelli Labs S.p.A. 4.1 Other 7.9 Total equity investments in subsidiaries 659.4 Equity investments in associates and other financial assets Mediobanca S.p.A. 105.3 RCS Mediagroup S.p.A. 57.9 Eurostazioni S.p.A. 52.9 CyOptics Inc. - U.S.A. 17.5 Fin. Priv. S.r.l. 14.4 Anastasia Real Estate Investment Trust 13.3 Alitalia S.p.A. 12.8 Advanced Digital Broadcast Holdings SA - Switzerland 9.8 Istituto Europeo di Oncologia S.r.l. 7.2 F.C. Internazionale Milano S.p.A. 6.0 Gruppo Banca Leonardo S.p.A. 5.2 Other 3.5 Total equity investments in associates and other financial assets 305.8 Total non-current financial assets 965.2 74 Annual Financial Report at December 31, 2010 Volume 1

Equity fell from euro 1,822.8 million at December 31, 2009 to euro 1,584.6 million at December 31, 2010. The change is illustrated as follows:

(in millions of euro) Equity at 12/31/2009 1,822.8 Effect of reduction in share capital (211.3) Net income 87.4 Dividends paid (81.1) Gains/(losses) recognised directly in Equity (33.2) Equity at 12/31/2010 1,584.6

The following table illustrates the breakdown of Equity at December 31, 2010 and comparative figures for the year at December 31, 2009:

(in millions of euro) 12/31/2010 12/31/2009 Share capital 1,375.7 1,554.3 Share premium reserve 229.4 229.7 Legal reserve 99.9 94.3 Business combinations reserve 22.5 22.5 Reserve from assignment of Pirelli RE (now Prelios) shares (32.5) — IAS transition reserve (239.4) (239.4) IAS operating reserve 15.7 48.8 Retained earnings 25.9 — Net income 87.4 112.6 1,584.6 1,822.8

The net financial position is positive for euro 597.2 million, which largely reflected the receipt of euro 258 million in dividends from subsidiaries, euro 208 million in cash received from the liquidated companies, and payment of a euro 81 million dividend to shareholders. Pirelli & C. S.p.A.: Highlights 75

(in thousands of euro) Surname and name Office held Office Period for which was held the office expiry Office in Emoluments for the office the company that draws up the financial statements (9) Non-monetary benefits Bonuses and other incentives (10) Other compensation Tronchetti Provera Marco Chairman 01/01//2010 - 31/12/2010 2010 fin. statements appr. 2,490 2,385 1,075 (1) Pirelli Alberto Deputy Chairman 01/01//2010 - 31/12/2010 2010 fin. statements appr. 640 5 (1) 110 (1) 368 (1) Puri Negri Carlo Alessandro Deputy Chairman 01/01/2010 - 29/07/2010 - 224 Malacalza Vittorio Deputy Chairman 29/07/2010 - 31/12/2010 2010 fin. statements appr. 21 (2) Acutis Carlo Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Angelici Carlo Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 74 (3) Antonelli Cristiano Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 74 (3) Benetton Gilberto Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Bombassei Alberto Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 70 (4) Bruni Franco Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 74 (3) Campiglio Luigi Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Cucchiani Enrico Tommaso Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Libonati Berardino Director 01/01//2010 - 30/11/2010 - 64 (6) Ligresti Giulia Maria Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Moratti Massimo Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Pagliaro Renato Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 (5) Paolucci Umberto Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 70 (4) Perissinotto Giovanni Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 50 Pesenti Giampiero Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 70 (4) Roth Luigi Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 74 (3) Secchi Carlo Director 01/01//2010 - 31/12/2010 2010 fin. statements appr. 89 (7) Gori Francesco General Manager 01/01/2010 - 31/12/2010 7 (1) 901 (1) 1,350 (1) Chairman, Board Laghi Enrico of Auditors 01/01//2010 - 31/12/2010 2010 fin. statements appr. 62 Gualtieri Paolo Statutory auditor 01/01//2010 - 31/12/2010 2010 fin. statements appr. 42 Sfameni Paolo Domenico Statutory auditor 01/01//2010 - 31/12/2010 2010 fin. statements appr. 57 (8)

Other executives with strategic responsibility 11 947 1,700

1) From Pirelli Tyre 2) In office since 29 July 2010 3) Of which Euro 24 thousand as member of the Internal Control, Risks and Corporate Governance Committee 4) Of which Euro 20 thousand as member of the Remuneration Committee 5) Emoluments deposited again in the company he/she belongs to 6) Of which Euro 18 thousand as member of the Remuneration Committee 7) Member of the Internal Control, Risks and Corporate Governance Committee (Euro 24 thousand) and of the Supervisory Body (Euro 15 thousand) 8) Of which Euro 15 thousand as member of the Supervisory Body 9) The items shown in this column contain Euro 50 thousand (except for Deputy Chairman Malacalza, for whom the item contains Euro 21 thousand and for Puri Negri, for whom it contains Euro 29 thousand) of compensation pertaining to the year 2010, to be received in 2011 10) The items shown in this column contain compensation pertaining to the year 2010, to be received in 2011

The Chairman, Deputy Chairman A. Pirelli, General Manager and the other executives with strategic responsibility are included in the LTI three-year incentive plan that according to the coinvestment mechanism, envisages disbursement of 50% of the incentive achieved for the years 2009 and 2010, while the remaining 50% accrued as a whole would be dis- bursed in 2012, increased by 100% in case three-year goals envisaged by the LTI 2009-2011 Plan are attained, otherwise reduced by 50% should said goals not be attained. Please refer to the text of the Corporate Governance Report, section “Remuneration of directors and remuneration policy” for more details on how the incentive plan works. 76 Annual Financial Report at December 31, 2010 Volume 1

OTHER INFORMATION Other information 77

EQUITY INTERESTS HELD & C. S.p.A. and in its subsidiaries by Directors, Statu- BY DIRECTORS, STATUTORY tory Auditors, General Managers and key managers, by their spouses if not legally separated and by their minor AUDITORS, GENERAL children, directly or through controlled companies, trust MANAGERS AND KEY companies or intermediaries, as resulting at December 31, 2010 from the Shareholders’ Register, from notices MANAGERS received and from other information acquired from the Pursuant to Article 79 of the Consob Regulation approved same Directors, Statutory Auditors, General Managers with Resolution no. 11971 of May 14, 1999, the table be- and key managers. low shows the equity interests held in the company Pirelli

Surname and name Investee company Number of Number Number of Number of shares held at of shares shares sold shares held at 12/31/2009 purchased/ 12/31/2010 subscribed Tronchetti Provera Marco Pirelli & C. S.p.A. 13,764 - - 1,251* Pirelli & C. S.p.A. (held indirectly) 1,369,504,3981 - - 124,500,500* Pirelli & C. S.p.A. (held indirectly) 1,217,3982 - - 110,673* Pirelli & C. Ambiente S.p.A. (held indirectly) 2,998,8002 1,605,779 2,364,299 2,240,2803 Pirelli & C. Eco Technology S.p.A. (held indirectly) 16,228,8002 - 7,501,900 8,726,9003 Pirelli Alberto Pirelli & C. S.p.A. 1,447,925 - - 131,629* Puri Negri Carlo Alessandro4 Pirelli & C. S.p.A. 66,500 - - 66,500 Moratti Massimo Pirelli & C. S.p.A. 11,551,427 - - 1,050,129* Pirelli & C. S.p.A. (held indirectly) 37,427,7325 - - 3,402,521* Pirelli & C. S.p.A. (held indirectly) 13,435,5446 - - 1,221,413* Roth Luigi Pirelli & C. S.p.A. 44,0007 - - 4,0007*

* The number of shares takes into account the reverse stock split carried out by Pirelli & C. S.p.A. on July 26, 2010. 1 Shares held through Camfin S.p.A. 2 Shares held through Cam Partecipazioni S.p.A. 3 The number of shares has been reduced due to share capital decrease and a further share capital increase (this for Pirelli & C. Ambiente S.p.A.), carried out during 2010. 4 Post of Director and Vice President held until July 29, 2010. 5 Shares held through CMC S.p.A. 6 Shares held in trust by Istifid S.p.A. 7 Shares held by spouse. STOCK OPTION PLANS SECURITY POLICY The information on stock option plans disclosed pursuant to DOCUMENT Consob Regulation no. 11971 of May 14, 1999 has been provided in the Explanatory Notes to the Financial Statements. In accordance with the provisions of Appendix B, par- The Company did not have any stock option plan in place agraph 26 of Legislative Decree 196 of June 30, 2003, at December 31, 2010. notice is given that Pirelli & C. S.p.A. has updated its Security Policy Document for the year 2010.

INFORMATION ON OWNERSHIP STRUCTURE (PURSUANT TO ART. 123 BIS OF THE CONSOLIDATED LAW ON FINANCE-TUF) The information pursuant to Article 123 bis of Legisla- tive Decree 58 of February 24, 1998 can be found in the Corporate Governance Report that accompanies the Fi- nancial Report and published in the Governance section of the Company website (www.pirelli.com). 78 Annual Financial Report at December 31, 2010 Volume 1

FOREIGN SUBSIDIARIES NOT IN THE EUROPEAN UNION (NON-EU COMPANIES)

Pirelli & C. S.p.A. directly or indirectly controls a number of companies with registered offices in countries that are not members of the European Union (Non-EU Compa- nies) and which are of material interest pursuant to Art. 36 of Consob Regulation 16191/2007 on market regulation (“Market Regulation”). At December 31, 2010, the Non-EU Companies that were directly or indirectly controlled by Pirelli & C. S.p.A. and of material interest pursuant to Article 36 of the Market Regulation were: Pirelli Pneus Ltda (Brazil); Pirelli Tire LLC (USA); Pirelli Tyre Co. Ltd (China); Turk Pirelli Lastikleri A.S. (Turkey); Pirelli de Venezuela C.A. (Ven- ezuela); Alexandria Tire Company S.A.E. (Egypt); Pirelli Neumaticos S.A.I.C. (Argentina). Also under the terms of the same regulations, the Com- pany has in place specific and appropriate “Group Op- erating Rules” which ensure immediate, constant and full compliance with the provisions contained in the said Consob Regulations1. Under the terms of the said Op- erating Rules, the competent corporate functions of the Parent precisely and periodically identify and disclose all Non-EU Companies of material interest under the Mar- ket Regulations, and – with the necessary and timely collaboration of the companies involved – guarantee collection of the data and information and verification of the circumstances as required by Article 36 of the Market Regulations, ensuring that the information and figures provided by the subsidiaries are available in the event of a request by Consob. Furthermore, a regular flow of information is provided for in order to ensure that the Board of Statutory Auditors of the Company can carry out the required and appropriate audits. Finally, the above “Op- erating Rules,” in keeping with the regulatory provisions, prescribe how the financial statements (balance sheet and income statement) of significant Non-EU Companies prepared for the purpose of the consolidated financial statements are to be made available to the public. Therefore, it is certified that the Company has fully complied with the provisions of Article 36 of Consob Regula- tion 16197/2007 and that its conditions have been satisfied.

1 Even before adoption of the aforementioned “Group Operating Rules,” the administrative, accounting and reporting systems in place at the Pirelli Group already allowed the Company to comply substantially with the regulatory requirements.

80 Annual Financial Report at December 31, 2010 Volume 1

RESOLUTIONS Resolutions 81

ALLOCATION OF NET RESULT —— having taken note that financial statements at December 31, 2010 contain a reserve designated “IAS transition Shareholders, reserve” for a negative amount of euro 239,425,665.64, The financial year at December 31, 2010 closed with net and that those same financial statements contain re- income of euro 87,404,079. serves designated “Share premium reserve” for a total of euro 229,431,693.83 and “Business combinations The Board of Directors proposes to distribute a dividend, reserve” for a total of euro 22,460,868.47 net of the required allocation to the legal reserve and gross of the required withholding taxes, of: —— euro 0.165 for each ordinary share; Resolves —— euro 0.229 for each savings share. a) to approve the Financial Statements of the Com- pany for the year ended December 31, 2010, as COVERAGE FOR THE IAS presented by the Board of Directors, in its entirety TRANSITION RESERVE and its individual captions, with the provisions proposed, which show a net income of euro 87,404,079;

An “IAS transition reserve” in the negative amount of euro b) to allocate the 2010 net income of euro 87,404,079 239,425,665.64 is reported in the 2010 financial state- as follows: ments. This reserve was generated as a result of adopting • 5% to the legal reserve euro 4,370,204 IFRSs and represents the effect of restating the financial • to the shareholders: statements of Pirelli & C. S.p.A. in application of the afore- ·· euro 0.165 (*) said accounting standards with respect to the previously to each of the 475,388,592 (**) applied Italian GAAP. In essence, the transition resulted in ordinary shares, for a total of euro 78,439,118 higher costs and lower revenues than the Company would ·· euro 0.229 (*) have had if it had adopted IFRSs even before their applica- to each of the 11,842,969 (**) tion, and the cumulative effect was reflected in the Com- savings shares, for a total of euro 2,712,040 pany Equity in the first year of adoption (2005). • the remainder to retained earnings euro 1,882,717 Because of its nature, the amount of that reserve cannot (*) Before the required withholding taxes be changed. The Board thus proposes to utilise other Eq- (**) Net of the 351,590 ordinary shares and 408,342 uity reserves to fully cover the “IAS transition reserve.” savings shares currently held by the Company More specifically, we propose drawing from the “Share premium reserve” the amount of euro 229,431,693.83, c) to authorise the directors, if the dividends specified at reducing that reserve to zero, and drawing the remaining sub-indent b) above are paid prior to the sale of the amount of euro 9,993,971.81 from the “Business com- treasury shares, to draw the amount of the dividend binations reserve”, which would thus be reduced to euro related to those shares from retained earnings and 12,466,896.66. to allocate to that item the balance of the rounding that may result from the dividend payment operation; From the tax standpoint, the proposed coverage will have no effect on profit and loss. d) to cover the “IAS transition reserve” entirely by utilising the entire amount of the “Share premium If you agree with our proposals, we ask you to pass reserve,” equal to euro 229,431,693.83, and euro the following 9,993,971.81 drawn from the “Business combinations reserve.”

Resolutions The dividend for 2010 will be collectible from May 26, 2011, with coupon detachment date on May 23, 2011. The Shareholders’ Meeting: —— having examined the Annual Financial Report at December 31, 2010; —— have taken note of the Board of Directors report on operations; —— having taken note of the reports of the Board of Stat- utory Auditors and the independent auditors; 82 Annual Financial Report at December 31, 2010 Volume 1

APPOINTMENT OF THE Together with such statements, a curriculum vitae must BOARD OF DIRECTORS be filed for each candidate, setting out their relevant personal and professional data and mentioning the offices held in management and supervisory bodies of —— Determination of the number of members of the other companies and specifying, where appropriate, the Board of Directors; grounds on which they qualify as an independent can- —— determination of the term in office of the Board of didate in accordance with the criteria established by law Directors; (art. 148, paragraph 3 of the TUF) and by the Corporate —— appointment of Directors Governance Code for the Listed Companies issued by —— determination of the annual compensation of the Borsa Italiana S.p.A. (adopted by the Company). members of the Board of Directors. Any changes that occur up to the date of the Sharehold- ers’ meeting must be promptly notified to the Company. Dear Shareholders, Any slates submitted without complying with the forego- the Board of Directors in office was appointed by the ing provisions shall be disregarded. General Meeting of Shareholders on April 29, 2008, which For your information – according to the provisions of the established in three years term the length of its office. Corporate Governance Self Code for Listed Companies – Therefore, the office of the Board of Directors will expire the Board of Directors has set the general criteria for deter- upon approval of the Company’s Financial Statements as mination of the maximum number of offices of its members. December 31, 2010. On this matter, please make reference to the appropriate The General Meeting of Shareholders has therefore to document containing the relevant details on the Company’s resolve upon the appointment a new Board of Directors, website www.pirelli.com, Corporate Governance section. after the determination of the number of its members, their term of office and remuneration. Having said that, the Board of Directors, On this point, Article 10 of the Company’s By-Laws (ful- —— acknowledging the provisions of the By-Laws con- ly quoted below) provides that the Board of Directors of cerning the composition and terms for appointing the Company must be composed of no less than 7 (seven) the Board of Directors; and no more than 23 (twenty three) members who shall —— invites the General Meeting: remain in office for three financial years, providing also • to determine the number of members of the that at the time of the Board’s appointment, the General Board of Directors, also determining their term Meeting of Shareholders can establish a shorter term at of office and remuneration; the time and that the Directors may be re-elected. • to vote on the slates of candidates for the office According to the same Article 10 of the Company’s By- of Director submitted and published according Laws, the Board of Directors shall be appointed on the to the provisions and with the terms provided by basis of slates presented by the shareholders who, alone Article 10 of the Company’s By-Laws. or together with other shareholders, hold a total number of shares representing at least 1,5 percent of the share capital entitled to vote at the Ordinary Shareholders’ Article 10 By-Laws meeting (threshold set by Consob Resolution No. 17633 of January 26, 2011), subject to their proving ownership 10.1 The Shareholders’ meeting shall establish the of the number of shares needed for the presentation of number of members of the Board of Directors, slates within the term specified for their publication by which shall remain unchanged until said meeting the Company. resolves otherwise. Shareholders planning to submit a slate shall identify 10.2 The Board of Directors shall be appointed on the themselves and prove their shareholding in the ordinary basis of slates presented by the Shareholders pur- share capital of the Company. suant to the following paragraphs hereof, in which The slates of candidates, listed by consecutive number, the candidates are listed by consecutive number. must be undersigned by the parties submitting them and 10.3 The slates presented by the , which must be under- filed at the Company’s registered office, and be available signed by the parties submitting them, shall be filed at least 25 days before the date set for the Shareholders’ at the Company’s registered office, and be available meeting to be held on first call. at least twenty five days before the date set for the Together with each slate, statements must be filed in shareholders’ meeting to be held on first call. They which the individual candidates agree to their nomina- are made available to the public at the registered of- tion and attest, under their own liability, that there are no fice, on the Company website and in the other ways grounds for their ineligibility or incompatibility, and that specified by Consob regulations at least 21 days be- they meet any requisites prescribed for the positions. fore the date of the general meeting. Resolutions 83

10.4 Each shareholder may present or take part in the If more than one candidate obtains the same quo- presentation of only one slate and each candidate tient, the candidate from the slate that has not yet may appear on only one slate on pain of ineligibility. elected a director or that has elected the lowest 10.5 Only shareholders who, alone or together with other number of directors shall be elected. shareholders, hold a total number of shares repre- If none of such slates has as yet elected a director senting at least 2 percent of the share capital entitled or they have all elected the same number of direc- to vote at the ordinary shareholders’ meeting or the tors, the candidate from the slate which obtained minor percentage, according to the regulations is- the highest number of votes shall be elected. If the sued by Commissione Nazionale per le Società e la different slates obtain the same number of votes Borsa, are entitled to submit slates, subject to their and their candidates are assigned the same quo- proving ownership of the number of shares needed tients, a new vote shall be held by the entire share- for the presentation of slates within the term speci- holders’ meeting and the candidate who obtains fied for their publication by the Company. the simple majority of the votes shall be elected. 10.6 Together with each slate, and within the respective 10.10 If the application of the slate voting system shall not terms specified above, statements must be filed ensure the appointment of the minimum number of in which the individual candidates agree to their independent Directors required by the law and/or nomination and attest, under their own liability, regulation, the appointed non-independent candi- that there are no grounds for their ineligibility or date indicated with the higher progressive number incompatibility, and that they meet any requisites in the slate which has obtained the higher number prescribed for the positions. of votes shall be replaced by the non-appointed in- Together with such statements, a curriculum vitae dependent candidate included in the same slate on must be filed for each candidate, setting out their the basis of the progressive order of the presentation relevant personal and professional data and men- and so on, slate by slate, until the minimum number tioning the offices held in management and super- of independent Directors shall be appointed. visory bodies of other companies and specifying, 10.11 When appointing directors who, for whatsoever where appropriate, the grounds on which they qual- reason were not appointed under the procedure ify as an independent candidate in accordance with established herein, the shareholders’ meeting shall the criteria established by law and the Company. vote on the basis of the majorities required by law. Any changes that occur up to the date of the 10.12 If one or more vacancies occur on the Board dur- Shareholders’ meeting must be promptly notified ing the course of the financial year, the procedure to the Company. established in article 2386 of the Italian Civil Code 10.7 Any slates submitted without complying with the shall be followed. foregoing provisions shall be disregarded. 10.13 In the event a Director cease to comply with 10.8 Each person entitled to vote may vote for only the independence requirements, this does not one slate. cause his/her ceasing to be a Director provided 10.9 The Board of Directors shall be elected as speci- that the Directors in office complying with le- fied below: gal independence requirements are a number at a) four-fifths of the directors to be elected shall be least equal to the minimum number requested chosen from the slate which obtains the high- by laws and/or regulations. est number of votes cast by the shareholders, in 10.14 The Board of Directors shall elect its own Chair- the order in which they are listed on the slate; man, if the shareholders’ meeting has not al- in the event of a fractional number, it shall be ready done so, and may also appoint one or more rounded-down to the nearest whole number; Deputy Chairmen. b) the remaining directors shall be chosen from the 10.15 In the absence of the Chairman, a Deputy other slates; to this end, the votes obtained by Chairman or a Managing Director, in that or- the various slates shall be divided by whole pro- der, shall act in his/her stead; should there be gressive numbers from one up to the number of two or more Deputy Chairmen or Managing Di- directors to be elected. rectors, the Board shall be presided over by the The quotients thus obtained shall be assigned to elder of same respectively. the candidates on each slate in the order they are 10.16 The Board of Directors shall appoint a Secretary, respectively listed thereon. On the basis of the who need not be a director. quotients assigned, the candidates on the various 10.17 Until the shareholders’ meeting resolves oth- slates shall be ranked in a single list in decreasing erwise, the directors shall not be subject to the order. Those who have obtained the highest quo- prohibition contemplated in article 2390 of the tient shall be elected. Italian Civil Code. 84 Annual Financial Report at December 31, 2010 Volume 1

REMUNERATION LTI Plan: the Long Term Incentive Cash Plan described GROUP REPORT in paragraph 9 of this Policy. Pirelli & C.: Pirelli & C. S.p.A.. GAS: the gross annual fixed component of remuneration FOREWORD of the employees of any Group Company. Senior Managers: the managers whom (i) Directors The General Remuneration Policy for the year 2011 holding special offices and who are assigned specific (“Policy”) sets out the principles and guidelines which functions and (ii) the General Directors of the Company the Pirelli Group refers to in order to (i) determine and whose activities have a significant impact on business re- (ii) monitor the implementation of remuneration prac- sults, first report to. tices described below. Company: Pirelli & C. S.p.A.. The Policy has been drafted in the light of the recommendations contained in Article 7 of the Self-Govern- ance Code of Borsa Italiana S.p.A., as amended in March 1. PRINCIPLES 2010, which Pirelli has adopted and which will enter into force as from the financial year 2012, and for the effects The Company defines and applies a General Remunera- of Article 14 of the Procedure for Related-Party Transac- tion Policy that is designed to attract, motivate and retain tions approved by the Company’s Board of Directors on the resources that have the professional skills necessary to November 3, 2010. successfully pursue the Group’s objectives. The 2010 Statement, presented for information purposes The Policy is defined so as to align the interests of the to the Shareholders’ Meeting, provides a final statement Management with those of shareholders, pursuing the about remunerations for the year 2010. primary objective of creating sustainable value in the To make it easier to read and understand this Report, medium-long term through the creation of a strong link please find below a glossary of the terms most frequently between remuneration, on the one hand, and individual used herein: and Group performances, on the other. Target-based Annual Total Direct Compensation: The Policy is the result of a clear and transparent process the sum of (i) the gross annual fixed component of remu- in which the Remuneration Committee and the Board of neration; (ii) the annual variable component that is based Directors of the Company play a key role. on the achievement of given target-based objectives; (iii) The Board of Directors adopts, upon proposal of the Re- the medium/long term annualization of the variable com- muneration Committee, the “Criteria for the Implemen- ponent (the so-called LTI) that is based on the achieve- tation of the General Remuneration Policy” (“Applica- ment of medium/long-term target-based objectives. tion Criteria”). General Directors: those appointed by the Board of Di- Any deviations from the Application Criteria when set- rectors in connection with the organizational structure of ting the remuneration: the Company and the Group. —— of Directors holding special offices, of General Di- Managers with strategic responsibilities: the manag- rectors and of Managers with strategic responsibili- ers identified by the Board of Directors of the Company, ties, are first examined and approved by the Remu- who have the power or responsibility to plan and control neration Committee and the Board of Directors; the Company’s activities or to take decisions which may —— of Senior Managers and Executives are first ap- affect its development or future prospects. proved by the Chief People Officer of the Company. Executives: Pirelli Group employees who meet specific At least once a year, during the presentation of the Re- requirements, set out in more detail in the Application muneration Statement, the Chief People Officer reports Criteria (as defined in paragraph 1 of the Policy), which about compliance with the Policy and about the cor- take account of the employee’s position within the organ- responding Application Criteria to the Remuneration izational structure, his autonomy, his decision-making Committee. power with respect to the company’s choices, his potential and performances. Group or Pirelli Group: all the companies included in 2. REMUNERATION COMMITTEE the consolidation of Pirelli & C. S.p.A.. Management: General Directors, Managers with stra- Since 2000, the Board of Directors has established among tegic responsibilities, Senior Managers and Executives its members the “Remuneration Committee” that has in- taken as a whole. vestigative, advisory and proactive functions. In particu- MBO: the annual variable component of remuneration lar, the Remuneration Committee: that is based on the achievement of pre-set business ob- —— makes proposals to the Board of Directors for the re- jectives. muneration of Directors holding special offices so as Resolutions 85

to ensure its alignment with the objective of creating 4. CONTENTS OF POLICY value for shareholders over the medium-long term; —— periodically reviews the remuneration criteria that The Policy, as stated above, sets out the principles and are applied to the Company’s Management and, guidelines which: upon request of the Directors holding special offices (i) the Board of Directors follows when setting the re- who are assigned specific functions, makes propos- muneration of: als and recommendations on this issue, especially for • the members of the Board of Directors and in the adoption of stock option/share-allocation plans; particular of Directors holding special offices; —— monitors the implementation of all decisions taken • General Directors; and of corporate policies on remuneration. • Managers with strategic responsibilities; The members of the Remuneration Committee, appoint- (ii) the Group refers to in order to set the remuneration ed by the Board of Directors during the meetings of April of Senior Managers and, in general, that of the Ex- 29, 2008 (Directors Berardino Libonati, Alberto Bom- ecutives of the Group. bassei, Giampiero Pesenti) and July 29, 2009 (Director Umberto Paolucci), are all independent directors. 5. THE REMUNERATION OF DIRECTORS On November 30, 2010, Director Berardino Libonati (Chairman) passed away. Consequently, at the time of this Within the Board of Directors, we can distinguish between: Report, the Remuneration Committee’s members are: (i) Directors holding special offices, who may also be —— Alberto Bombassei; assigned specific functions; —— Umberto Paolucci; (ii) Directors who do not hold special offices. —— Giampiero Pesenti The granting of powers to Directors only for urgent mat- The Board of Directors has granted the Remuneration ters does not qualify them as Directors who have been Committee the powers of the Committee for Related-Par- assigned specific functions. ty Transactions though solely with respect to any decisions As of December 31, 2010: regarding the remuneration of Directors holding special —— the Chairman of the Board of Directors, Marco offices and of Managers with strategic responsibilities. Tronchetti Provera, and the Deputy Chairmen, Al- For a full description of the operation and activities car- berto Pirelli and Vittorio Malacalza, were Directors ried out in 2010 by the Remuneration Committee, please holding special offices; the Chairman had also been refer to the Report on Corporate Governance and Own- assigned specific functions (for further information ership Structure for the year 2010. on this issue, please refer to the Report on Corporate Governance and Ownership Structure); —— the following Directors did not hold special offices: 3. PROCESS FOR THE DEFINITION AND Carlo Acutis; Carlo Angelici; Cristiano Antonelli; ADOPTION OF THE POLICY Gilberto Benetton; Alberto Bombassei; Franco Bruni; Luigi Campiglio; Enrico Tommaso Cucchi- The Policy is submitted by the Remuneration Committee ani; Giulia Maria Ligresti; Massimo Moratti; Renato to the Board of Directors every year. Pagliaro; Umberto Paolucci; Giovanni Perissinotto; The Board of Directors, after reviewing and approving Giampiero Pesenti; Luigi Roth; Carlo Secchi. the Policy, submits it to the advisory vote of the Share- In April 2008, the Shareholders’ Meeting of Pirelli, upon holders’ Meeting. appointment of the Board of Directors, set the Direc- The Remuneration Committee submits also the “Appli- tors’ total remuneration (under art. 2389(1) Italian Civil cation Criteria” to the Board of Directors’ approval and Code), granting the Board of Directors the task of deter- oversees their implementation. mining its allocation. The Policy, which was approved by the Remuneration In particular, the Shareholders’ Meeting of April 2008 Committee at its meeting on February 23, 2011, was approved a total gross annual remuneration of euro 1.2 also evaluated during a specific meeting of all Independ- million, allocated as follows by the Board of Directors: ent Directors; it was then approved by the Board of Di- —— euro 50,000 for each member of the Board of Directors; rectors at its meeting on March 8, 2011 and submitted —— euro 24,000 for each member of the Internal Audit, to the examination and advisory vote of this Sharehold- Risk and Corporate Governance Committee; ers’ Meeting. —— euro 20,000 for each member of the Remunera- tion Committee. In line with best practices, Directors not holding special offices (as defined above) were not granted a variable component of their remuneration. 86 Annual Financial Report at December 31, 2010 Volume 1

A euro15,000 salary was granted to the Director who was a (target-based MBO and target-based LTI) of the member of the Supervisory Board. target-based Annual Total Direct Compensation. Directors were also entitled to a refund of expenses in- For further information, also about maximum incentive curred for business reasons. limits, please refer to paragraph 9 (“MBO and LTI Plan”). In line with best practices, the Company applies an in- If a Director holds special offices though is not assigned surance policy called D&O (Directors & Officers) Liabil- specific functions, his remuneration package consists ex- ity covering the third party liability of corporate bodies, clusively of an annual fixed component that takes into General Directors, Managers with strategic responsibili- account the particular office held thereby. ties, Senior Managers and Executives in the performance With reference to the variable components of the remu- of their functions, which is designed to indemnify the neration package of Directors holding special offices, Group against the cost of any ensuing compensation de- please note that the Remuneration Committee proposes riving from the relevant provisions of the applicable na- the MBO objectives to the Board of Directors on an an- tional collective agreement and from the provisions on nual basis and then checks, in the following year, the Di- assignments, though excluding the case of willful miscon- rectors’ performances to verify their achievement of the duct and gross negligence. MBO objectives in the previous year. Please note that upon approval of the Financial Statements The Remuneration Committee is also responsible for of the year that ended on December 31, 2010, the Share- evaluating the proposed allocation and quantification of holders’ Meeting will also be required to renew the Board the LTI in case of achievement of the objectives of the of Directors. LTI Plan. By analogy with what is guaranteed by law and/or by the National Collective Agreement for the Italian managers 6. REMUNERATION OF DIRECTORS HOLDING of the Group, the Board of Directors may also grant Di- SPECIAL OFFICES rectors holding special offices and who have been assigned specific functions, At the time of their appointment or at the first meeting provided they do not have a management contract with thereafter, the Remuneration Committee proposes to the the Group: Board of Directors the remuneration package for Direc- —— a Retirement Bonus (Trattamento di Fine Man- tors holding special offices. dato -T.F.M.) as under art. 17(1), letter c) of the The remuneration package of Directors holding special Consolidated Income Tax Law No 917/1986 with offices generally consists of the following elements: characteristics similar to those of the Severance Pay —— a gross annual fixed component; (Trattamento di Fine Rapporto - TFR) as under art. —— an annual variable component that is based on the 2120 Italian Civil Code, granted by law to the Italian achievement of pre-set business objectives (the so- managers of the Group and including the contribu- called MBO); tions to be paid by the employer which would be due —— a medium/long term, variable component (the so- to social security institutions or funds in the case of a called LTI). management contract with the Group.. When setting remuneration and its single elements, the —— a policy (i) against personal accidents occurred while Board of Directors takes into account whether the Di- fulfilling their assignment, and (ii) against extra-pro- rector holding a special office has been assigned specific fessional accidents with premiums charged to the functions. In particular, salary levels are set on the basis Company; for the latter accidents, the premium is of the following indicative criteria: payable by the Company according to tax and fiscal a) the fixed component generally represents no more regulations; than 50% of the target-based Annual Total Direct —— compensation in case of permanent disability and Compensation; death due to disease; b) the (annual) target-based MBO incentive is a prede- —— further benefits typical of their office and currently termined percentage of the fixed salary of Directors granted within the Group to Managers with strategic holding special offices in the Company (excluding, responsibilities and/or Senior Managers. therefore, the remuneration received for other offices The Board of Directors may provide for (or, if required by in other Group companies) representing generally law, may suggest to the Shareholders’ Assembly) incen- not less than 70% of their salary. In any case, the tive mechanisms through the award of financial instru- maximum incentive can not be 2 times greater than ments or options on financial instruments which, where the gross annual fixed component/GAS; approved, are disclosed in the Annual Remuneration c) The medium/long term, variable, target-based annu- Statement at the latest (without prejudice to any further alized component (the so-called LTI) generally rep- transparency obligations required by applicable laws). resents at least 50% of the total variable component Resolutions 87

As of the date of this Report, the Company has no incen- b) the (annual) target-based MBO incentive for Gen- tive plans through financial instruments. eral Directors is a predetermined percentage of their fixed gross annual salary, representing generally not It is a policy of the Group not to award discretionary bo- less than 70% of their salary, while for Managers nuses to Directors holding special offices. with strategic responsibilities it represents not less The Board of Directors, upon proposal of the Remu- than 40% of their fixed gross annual salary. neration Committee, may grant bonuses to these figures c) The medium/long term, variable, target-based annu- for specific transactions that are deemed exceptional in alized component (the so-called LTI) generally rep- terms of strategic importance and effects on the results of resents at least 50% of the total variable component the Company and/or the Group. (target-based MBO and target-based LTI) of the target-based Annual Total Direct Compensation. The Remuneration Committee and the Board of Direc- For further information, also about maximum incentive tors evaluate and approve in advance, respectively, any limits, please refer to paragraph 9 (“MBO and LTI Plan”). further remuneration elements awarded to Directors Just like for Directors holding special offices, the Board for any other special offices granted thereto within the of Directors may provide for (or, if required by law, may Boards of Directors of the Company’s subsidiaries. suggest to the Shareholders’ Assembly) incentive mecha- It is up to the Remuneration Committee and to the Board nisms through the award of financial instruments or op- of Directors to analyse the composition and, more generally, tions on financial instruments which, where approved, are the competitiveness of the remuneration packages of Direc- disclosed in the Annual Remuneration Statement of the tors holding special offices. When doing so, they are assisted following year at the latest (without prejudice to any fur- by independent firms specialized in executive compensation ther transparency obligations required by applicable laws). on the basis of methodological approaches that allow for the As said in the previous paragraph, as of the date of this complexity of the Directors’ offices to be assessed in organi- Report the Company has no incentive plans through fi- zational terms, according to their specific assigned functions nancial instruments. and to their individual impact on final business results. It is a policy of the Group not to award discretionary bonuses to General Directors and to Managers with strategic responsibilities. 7. GENERAL DIRECTORS AND MANAGERS The Board of Directors, upon proposal of the Remu- WITH STRATEGIC RESPONSIBILITIES neration Committee, may grant bonuses to these figures for specific transactions that are deemed exceptional in As of December 31, 2010, Mr. Francesco Gori was the terms of strategic importance and effects on the results of sole General Director of Pirelli & C., while the Managers the Company and/or the Group. with strategic responsibilities were: The process for setting the remuneration of General Di- —— Atty. Francesco Chiappetta; rectors is similar to that described for Directors holding —— Mr. Francesco Tanzi; special offices. —— Mr. Maurizio Sala. With regard to Managers with strategic responsibilities, The Board of Directors, assisted by the Internal Audit, Risk the Remuneration Committee checks whether their re- and Corporate Governance Committee, checks at least muneration is consistent with the Policy. once a year that these conditions are not met with respect to Also the remuneration of General Directors and of Man- further executives of the Company and/or the Group. agers with strategic responsibilities is analyzed with the The remuneration package of General Directors and of assistance of independent firms specialized in executive Managers with strategic responsibilities generally con- compensation, and its levels are reviewed annually and an- sists of the following elements: nounced in the Annual Remuneration Statement. —— a gross annual fixed component (the so-called GAS); —— an annual variable component that is based on the achievement of pre-set business objectives (the so- 8. SENIOR MANAGERS AND EXECUTIVES called MBO); —— a medium/long term, variable component (the so- The remuneration package of Senior Managers and Ex- called LTI). ecutives in general consists of the following elements: —— benefits typically granted to Pirelli executives. —— a gross annual fixed component (the so-called GAS); When setting remuneration and its single elements, the —— an annual variable component that is based on the Board of Directors considers the following indicative criteria: achievement of pre-set business objectives (the so- a) the fixed component generally represents no more called MBO); than 50% of the target-based Annual Total Direct —— a medium/long term, variable component (the so- Compensation; called LTI). 88 Annual Financial Report at December 31, 2010 Volume 1

—— benefits granted according to corporate practices. economic and/or quality performance of the unit/func- When setting the remuneration of Senior Managers and tion which the worker is a member of. Executives and its single elements, the Pirelli Group con- The Group sets a “cap” on the incentive payable in case siders the following indicative criteria: the target objectives are exceeded. a) the fixed component: (i) for Senior Managers gen- In particular, in the case of MBOs granted to Direc- erally represents no more than 60% of the target- tors holding special offices and to General Directors, based Annual Total Direct Compensation and (ii) for the maximum incentive can not be 2 times greater than Executives it generally represents no more than the gross annual fixed component/GAS. In the case of two thirds of the target-based Annual Total Direct Managers with strategic responsibilities, the maximum Compensation; incentive can not be 1.5 times greater than their GAS. b) an (annual) target-based MBO incentive that is a Lastly, the maximum incentive for Senior Managers and percentage of the fixed component; Executives cannot be 2 times greater than the target- c) The medium/long term, variable, target-based an- based incentive. nualized component (the so-called LTI) (i) for Sen- Also for the purposes of fostering the achievement of ior Managers represents at least 50% of the total medium/long term interests, the Group has adopted variable component (target-based MBO and target- since 2009 a medium/long term incentive system that based LTI) of the target-based Annual Total Direct is based on the achievement of the objectives set out in Compensation and (ii) for Executives (unless the ex- the three-year plan (the “2009/2011” plan - involving ecutive is not included, for management purposes, some 90 people, in particular Directors holding special in the LTI Plan) it represents at least 30% of the offices and who are assigned specific functions, Gen- total variable component (target-based MBO and eral Directors, Managers with strategic responsibilities, target-based LTI) of the target-based Annual Total Senior Managers and some Executives - and then the Direct Compensation. “2011/2013” plan, essentially extended to all other Ex- For further information, also about maximum incentive ecutives of the Group). limits, please refer to paragraph 9 (“MBO and LTI Plan”). The LTI Plan also includes a mechanism for the “co-in- The Group may grant exceptional bonuses in case of ur- vestment” of a portion of the MBO: the participant in the gent management needs or in case of the achievement LTI Plan “co-invests” 50% of his MBO 2011 and 2012, of specific extraordinary targets, and may include these eventually achieved thereby, to “support” the achieve- workers in incentive mechanisms through the allocation ment of the objectives of the Three-Year Business Plan. of financial instruments or options on financial instru- If the objectives of the Three-Year Business Plan are ments adopted by the Group. In this respect, as said achieved, the participant acquires an LTI incentive above, as of the date of this Report the Company has no which is a percentage of his gross annual fixed compo- incentive plans through financial instruments. nent/GAS applied at the time of joining the Plan; this percentage takes into account the role played thereby. The maximum incentive cannot be 1.5 times greater 9. MBO AND LTI PLAN than the incentive granted for the achievement of target objectives. The annual variable component (the so-called MBO) is In case of failure to achieve the target objectives, the used to evaluate the recipient’s performance on an annual worker is not entitled, not event pro-rata, to receive the basis. The MBO objectives for Directors holding special LTI incentive. offices and who are assigned specific functions, of Gener- With regard to the portion of co-invested MBO, the al Directors and of Managers with strategic responsibili- worker - if the three-year objectives are achieved - may ties, are set by the Board of Directors upon proposal of claim the “return” of the “invested” amount, increased by the Remuneration Committee, and are connected to the a sum amounting to the “invested” one; if the three-year Company’s and the Group’s annual performances. objectives are not achieved, the worker is entitled to claim The annual variable component is based on the achieve- only a refund of half the amount invested. ment of a financial condition of access (the so-called on/ Therefore, the incentive plan provides for the partial de- off condition) - in 2010, the Net Financial Position - and ferment of payment of MBOs 2011 and 2012 (and of is related to a quantitative benchmark of annual profit- MBOs 2009 and 2010 for the LTI Plan 2009/2011). ability (in 2010, PBIT). The costs of LTI incentives are included in the objectives The MBOs of Senior Managers and Executives are de- of the Three-Year Business Plan, so that the cost of the fined by their hierarchical superiors together with the HR LTI Plan is “self-financed” by the achievement of these Department and the Group Management Control De- objectives. partment and may include, in addition to the Company’s The allocation of a portion of the amount granted on top and/or Group’s performances, objectives related to the of the “invested” one (10% of that amount) is connected Resolutions 89

to the Total Shareholder Return, which measures Pirelli annual fixed salaries for the offices held; the average annual performances compared to the FTSE/MIB Total Return MBO paid while in office; Severance Pay on these amounts). index, periodically calculated by FTSE and available in the Italian Stock Exchange database, which Pirelli’s TSR must be at least aligned with in order to ensure an even 11. NON-COMPETITION AGREEMENTS greater alignment between the Management’s performances and the expectations of shareholders. This rela- The Group may enter into non-competition agreements tion is aimed at guaranteeing a direct link between pay with its General Directors, Managers with strategic re- and sustainable performances, meant in terms of value sponsibilities and for especially important professional growth in the medium and long term. roles of Senior Managers and Executives, providing for The LTI Plan also has retention purposes: in the event of payment of a GAS-related fee in relation to the term and termination, for any reason, of the worker’s assignment scope of the obligation resulting from the agreement itself. and/or employment relationship before the end of the The obligation is referred to the industry which the three-year period, the worker no longer takes part in the Group works in at the time of the agreement and to its Plan and thus the three-year incentive is not paid thereto, geographical scope. The scope of the obligation varies ac- not even pro-rata (this applies also to MBO shares that cording to the worker’s role at the time of execution of may have already been “invested”). the agreement and may cover, as in the case of General Directors, all the countries which the Group works in.

10. ALLOWANCES IN THE EVENT OF RESIGNATION, DISMISSAL OR TERMINATION

It is a policy of the Pirelli Group not to enter into agreements with Directors, Managers with strategic responsibilities, Senior Managers and Executives that regulate ex ante the economic issues arising in case of early termination of their relationship by the Company or the worker (the so-called “golden parachutes”). If the worker’s relationship with the Group is terminated other than for good cause, it is preferable to “close” the relationship by mutual agreement. Subject to statutory and/or contractual obligations, any agreement on termination of the worker’s relationship with the Group is based on the applicable benchmarks in this field and is subject to the case-law/customary limits applied in the country where the agreement is reached. The Company defines internally the criteria which also the other companies of the Group must follow for the management of agreements on the early termination of relationships with managers and/or Directors holding special offices. With regard to Directors holding special offices and who are assigned specific functions and who do not have a management contract with the Group, the Company does not provide for the payment of allowances or extraordinary compensation related to termination of their office. Payment of a specific allowance may be granted, subject to the prior assessment of the competent corporate bodies, in the following cases: —— termination by the Company without good cause; —— termination by the Director for good cause; for example, in case of substantial changes to his role or to his assignments and/or in case of a so-called “hos- tile” tender offer. In these cases, the allowance amounts to 3 times the work- The Board of Directors er’s gross annual salary, this meaning the sum of (all gross Milan, March 8, 2011 90 Annual Financial Report at December 31, 2010 Volume 1 consolidated financial Statements Consolidated financial statements 91

CONSOLIDATED BALANCE SHEET (in thousands of euro) 12/31/2010 12/31/2009 of which related of which related parties parties 8 Property, plant and equipment 1,977,106 1,727,391 9 Intangible assets 848,761 1,047,474 10 Investments in associates and joint ventures 152,927 593,237 11 Other financial assets 185,267 228,106 12 Deferred tax assets 69,642 91,164 14 Other receivables 315,531 557,230 395,220 15 Tax receivables 10,755 9,578 Non-current assets 3,559,989 4,254,180 16 Inventories 692,259 678,977 13 Trade receivables 676,681 8,067 735,792 91,484 14 Other receivables 174,982 149,754 197,144 19,094 17 Securities held for trading 209,770 161,024 18 Cash and cash equivalents 244,725 632,113 15 Tax receivables 25,235 41,464 27 Derivative financial instruments 35,159 26,567 Current assets 2,058,811 2,473,081 Total Assets 5,618,800 6,727,261

19.1 Equity attributable to owners of the Parent: 1,990,831 2,175,023 —— Share capital 1,375,733 1,554,269 —— Reserves 593,346 598,009 —— Net income 21,752 22,745 19.2 Equity attributable to non-controlling interests: 37,152 319,648 —— Reserves 54,675 364,979 —— Net income (17,523) (45,331) 19 Total Equity 2,027,983 2,494,671

24 Borrowings from banks and other financial institutions 894,711 1,505,805 26 Other payables 41,664 34,008 2,608 22 Provisions for liabilities and charges 165,732 167,793 12 Provision for deferred tax liabilities 33,733 44,000 23 Employee benefit obligations 481,724 451,880 21 Tax payables 5,547 10,037 Non-current liablities 1,623,111 2,213,523 24 Borrowings from banks and other financial institutions 247,515 77 289,305 2,473 25 Trade payables 1,066,361 5,434 987,873 24,067 26 Other payables 403,373 1,174 491,035 10,798 22 Provisions for liabilities and charges 115,984 130,783 3,279 21 Tax payables 64,559 43,918 1,080 27 Derivative financial instruments 69,914 76,153 Current liabilities 1,967,706 2,019,067 Total Liabilities and Equity 5,618,800 6,727,261

Related party transactions in respect of the individual line items in the financial statements are presented in Note 42 of the Explanatory Notes to which the reader is referred 92 Annual Financial Report at December 31, 2010 Volume 1

CONSOLIDATED INCOME STATEMENT (in thousands of euro) 2010 2009 of which of which related parties related parties 29 Revenue from sales and services 4,848,418 5,597 4,067,461 1,455 30 Other income 154,333 1,798 147,144 —— of which non-recurring events - 5,900 Change in inventories of work in progress, semi-finished and finished products 34,404 (109,143) Raw materials and consumables (net of change in inventories) (1,904,980) (1,372,727) 31 Personnel expense (1,063,648) (5,334) (949,217) (12,693) —— of which non-recurring events (18,192) (52,124) 32 Amortisation, depreciation and impairment (228,598) (219,348) —— of which non-recurring events (6,500) (8,000) 33 Other costs (1,443,082) (22,959) (1,317,172) (16,367) —— of which non-recurring events - (1,000) Additions to property, plant & equipment for internal work 10,916 2,681 Operating income 407,763 249,679 34 Net income (loss) from equity investments 23,457 (11,600) —— share of net income of associates and joint ventures 256 256 225 225 —— gains on equity investments 23,831 17,893 —— losses on equity investments (6,465) (36,619) —— dividends 5,835 6,901 35 Financial income 297,534 1,134 344,760 36 Financial expenses (363,327) - (414,873) Net income (loss) before income taxes 365,427 167,966 37 Income taxes (137,358) (90,350) Net income (loss) from continuing operations 228,069 77,616 38 Net income (loss) from discontinued operations (223,840) (100,202) Net income (loss) 4,229 (22,586) Attributable to: Owners of the Parent 21,752 22,745 Non-controlling interests (17,523) (45,331)

39 Earnings (losses) per share (euro/thousand shares) basic earnings per share —— continuing operations 479,66 161,39 —— discontinued operations (435,04) (114,73) 44,62 46,66

Related party transactions in respect of the individual line items in the financial statements are presented in Note 42 of the Explanatory Notes to which the reader is referred Consolidated financial statements 93

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in thousands of euro) 12/31/2010 Gross Income taxes Net A Net income (loss) for the period 4.229 Other components recognised in Equity: (Gains)/losses on associates and joint ventures transferred to income statement, previously recognised in Equity 38,854 (1,335) 37,519 (Gains)/losses on other financial assets transferred to income statement, previously recognised in Equity (8,656) - (8,656) (Gains)/losses on cash flow hedges transferred to income statement, previously recognised directly in Equity 5,683 (1,508) 4,175 B (Gains)/losses transferred to income statement previously recognised directly in Equity 35,881 (2,843) 33,038 Exchange differences from translation of foreign financial statements 104,667 - 104,667 Fair value adjustment of other financial assets (33,678) - (33,678) Net actuarial gains/(losses) on employee benefits (21,618) 3,053 (18,565) Fair value adjustment of derivatives designated as cash flow hedges (8,893) 2,967 (5,926) Share of other components recognised in Equity related to associates and joint ventures (561) - (561) Other components recognised in Equity related to discontinued operations 2,691 (368) 2,323 C Income/(losses) recognised directly in Equity in the period 42,608 5,652 48,260

B+C Total other components recognised in Equity 78,489 2,809 81,298

A+B+C Total comprehensive income/(losses) 85,527 Attributable to: —— Owners of the Parent 96,525 —— Non-controlling interests (10,998)

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in thousands of euro) 12/31/2009 Gross Income taxes Net A Net income (loss) for the period (22.586) Other components recognised in Equity: (Gains)/losses on associates and joint ventures transferred to income statement, previously recognised directly in Equity 11,406 - 11,406 (Gains)/losses on other financial assets transferred to income statement, previously recognised in Equity (792) - (792) (Gains)/losses on cash flow hedges transferred to income statement, previously recognised directly in Equity (1,934) - (1,934) B (Gains)/losses transferred to income statement previously recognised directly in Equity 8,680 - 8,680 Exchange differences from translation of foreign financial statements 37,589 - 37,589 Fair value adjustment of other financial assets 34,739 (226) 34,513 Net actuarial gains/(losses) on employee benefits (86,643) 9,157 (77,486) Adjustment to fair value of derivatives designated as cash flow hedges (18,639) 5,223 (13,416) Reversal of reserve for reclassification of Equity investments from other financial -as sets to associates 12,281 (506) 11,775 Share of other components recognised in Equity related to associates and joint ventures (13,566) 463 (13,103) C Income/(losses) recognised directly in Equity in the period (34,239) 14,111 (20,128)

B+C Total other components recognised in Equity (25,559) 14,111 (11,448)

A+B+C Total comprehensive income/(losses) (34,034) Attributable to: —— Owners of the Parent 10,307 —— Non-controlling interests (44,341) 94 Annual Financial Report at December 31, 2010 Volume 1

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (in thousands of euro) attributable to owners of the Parent Non- Total Share Translation Total IAS Other Total controlling capital reserve reserves* reserves/ attributable interests Retained to owners of earnings the Parent Total at 12/31/2008 1,554,269 (15,422) (292,214) 925,171 2,171,804 202,558 2,374,362 Total other components recognised in Equity - 40,656 (53,094) - (12,438) 990 (11,448) Net income (loss) - - - 22,745 22,745 (45,331) (22,586) Total gains/(losses) - 40,656 (53,094) 22,745 10,307 (44,341) (34,034) Pirelli RE capital increase - - 986 (3,588) (2,602) 165,527 162,925 Dividends paid - - - - - (2,313) (2,313) Changes in non-controlling interests - - - - - (4,349) (4,349) Other - - (1,905) (2,581) (4,486) 2,566 (1,920) Total at 12/31/2009 1,554,269 25,234 (346,227) 941,747 2,175,023 319,648 2,494,671 Total other components of continuing operations recognised in Equity - 101,358 (63,204) - 38,154 3,301 41,455 Total other components of discontinued operations recognised in Equity - 835 35,736 - 36,571 3,272 39,843 Net income (loss) from continuing operations - - - 233,821 233,821 (5,752) 228,069 Net income (loss) from discontinued operations - - - (212,069) (212,069) (11,771) (223,840) Total gains/(losses) - 102,193 (27,468) 21,752 96,477 (10,950) 85,527 Reduction for spin-off of Pirelli RE (178,814) - (3,976) (32,498) (215,288) (274,831) (490,119) Dividends paid - - - (81,114) (81,114) (3,968) (85,082) Venezuela inflation effect - - - 15,017 15,017 558 15,575 Capital increases - - - - - 4,794 4,794 Other 278 - (1,238) 1,676 716 1,901 2,617 Total at 12/31/2010 1,375,733 127,427 (378,909) 866,580 1,990,831 37,152 2,027,983

BREAKDOWN OF IAS RESERVES* (in thousands of euro) Reserve Reserve for Reserve Reserve Reserve Total IAS for adjustment cash flow for actuarial for Equity for deferred reserves to fair value of hedges gains/losses settled stock taxes available-for- options sale financial assets Balance at 12/31/2008 17,323 (37,983) (297,339) 3,500 22,285 (292,214) Total other components recognised in Equity 40,886 (21,746) (86,323) - 14,089 (53,094) Other changes (454) (1,049) (231) - 815 (919) Balance at 12/31/2009 57,755 (60,778) (383,893) 3,500 37,189 (346,227) Total other components of continuing operations recognised in Equity (42,334) (3,771) (21,608) - 4,509 (63,204) Total other components of discontinued operations recognised in Equity 710 37,288 (765) - (1,497) 35,736 Other changes in discontinued operations - - 380 (3,500) (856) (3,976) Other changes in continuing operations - (248) (3) - (987) (1,238) Balance at 12/31/2010 16,131 (27,509) (405,889) - 38,359 (378,909) Consolidated financial statements 95

CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands of euro) 2010 2009 of which of which related related parties parties Net income (loss) from continuing operations before taxes 365,427 167,966 Amortisation, depreciation, impairment losses and reversals of property, plant and equipment and intangible assets 228,598 219,348 Reversal of financial expenses 363,327 414,873 Reversal of financial income (297,534) (344,760) Reversal of dividends (5,835) (6,901) Gains/(losses) on equity investments (17,366) 18,726 Share of net income from associates and joint ventures (net of dividends received) (256) (225) Income taxes (137,358) (90,350) Change in inventories (109,919) 245,391 Change trade receivables/payables 127,959 (101,565) Change in other receivables/payables 51,046 5,598 Change in provisions for employee benefits and other provisions 41,947 67,912 Other changes 18,052 (64,034) A Net cash flows provided by/(used in) operating activities 628,088 531,979 Purchase of property, plant and equipment (433,069) (17,901) (223,221) Disposal of property, plant and equipment 17,954 37,303 Purchase of intangible assets (4,828) (4,563) Disposals of intangible assets 2,832 10,116 Acquisition of equity investments in associates and joint ventures (16,904) (13,791) Acquisition of other financial assets (23,516) (1,117) (1,527) Disposal of other financial assets - 223,839 Acquisition of non-controlling interests - (4,166) Dividends received 5,835 6,901 B Net cash flows provided by/(used in) investing activities (451,696) (30,891) Increase/(reduction) in Equity 4,794 Change in financial payables (186,448) (95,787) Change in financial receivables (235,416) (6,099) Financial income/(expenses) (65,793) (70,113) Dividends paid (85,082) (20,780) (2,313) C Net cash flows provided by/(used in) financing activities (567,945) (174,312) Net cash flows provided by/(used in) operating activities (8,025) (8,823) Net cash flows provided by/(used in) investing activities (1,020) 5,163 Net cash flows provided by/(used in) financing activities 11,275 1,164 D Net cash flows provided by/(used in) discontinued operations 2,230 (2,496)

E Total cash flows provided/(used) during the year (A+B+C+D) (389,323) 386,062

F Cash and cash equivalents at beginning of year 610,779 227,077

G Exchange differences on translation of cash and cash equivalents 5,314 (2,360)

H Cash and cash equivalents at end of year (E+F+G) ° 226,770 610,779

° of which: cash and cash equivalents 244,725 632,113 bank overdrafts (17,955) (21,334)

The Statement of Cash Flows shows transactions with related parties only if they cannot be directly deduced from the other statements. Related party transactions in respect of the individual line items in the financial statements are presented in Note 42 of the Explanatory Notes to which the reader is referred 96 Annual Financial Report at December 31, 2010 Volume 1

1. GENERAL INFORMATION than include these components directly in the statement of comprehensive income. The income statement clas- Pirelli & C. S.p.A. is a corporation organised under the sifies costs by nature. laws of the Republic of Italy. The statement of comprehensive income includes the Founded in 1872 and listed on the Italian Stock Exchange, result for the period and, for homogeneous categories, Pirelli & C. S.p.A. is a holding company that manages, co- the revenues and costs which, in accordance with IFRSs, ordinates and finances the operations of its subsidiaries. are recognised directly in equity. At the reporting date, the Group’s operations are princi- The Group has decided to present both the tax effects pally represented by investments in: and reclassifications to the income statement of gains/ —— Pirelli Tyre S.p.A. – a company operating in the tyre losses recognised directly in equity in previous periods sector – 100% stake in share capital; directly in the statement of comprehensive income and —— Pirelli & C. Eco Technology S.p.A. – a company ac- not in the explanatory notes. tive in the field of emission reducing technologies – The Statement of Changes in Equity includes the amounts 51% stake in share capital; of transactions with the Equity holders and the movements —— Pirelli & C. Ambiente S.p.A. – a company operating that occurred during the period in retained earnings. in the field of renewable sources of energy –51% stake in share capital. In the Cash Flow Statement, the cash flows deriving from operating activities are presented using the indirect meth- The head office of the company is located in Milan, Italy. od, according to which the profit or loss for the period is adjusted by the effects of non-monetary transactions, by Pursuant to Article 5(2) of Italian Legislative Decree 38 any deferment or accrual of past or future operating re- of February 28, 2005, these financial statements have ceipts or payments, and by any revenue or cost items con- been prepared using the euro as the functional currency, nected with the cash flows arising from investing activities and all amounts have been rounded to the nearest thou- or financing activities. sand euro unless indicated otherwise. When reading the financial statements, it should be re- The consolidated financial statements are audited by Re- called that the assets and activities of Pirelli & C. Real conta Ernst & Young S.p.A., pursuant to Article 159 of Estate S.p.A., now Prelios S.p.A. (following Pirelli RE – Italian Legislative Decree 58 of February 24, 1998, the now Prelios) were spun off from the Pirelli Group effec- Consob recommendation of February 20, 1997, and the tive October 25, 2010 so that the Group could concen- shareholders’ meeting resolution of April 29, 2008, which trate on the Tyre business. This spin off simultaneously engaged this accounting firm for the period 2008-2016. allowed shareholders, who already had an indirect equity interest in the real estate business, to acquire a direct in- On March 8, 2011 the consolidated financial statements vestment in Prelios S.p.A.. have been authorised for issue by the Board of Directors. On November 29, 2010, the Advanced Digital Broadcast (ADB) Group acquired 100% of Pirelli Broadband Solu- tions S.p.A. (PBS), a wholly-owned subsidiary of Pirelli 2. BASIS OF PRESENTATION & C. S.p.A.. Both of these transactions have been classified as discon- FINANCIAL STATEMENT FORMATS tinued operations, and thus contributed only to the net income (loss). Therefore, the comparative income state- The Company has applied the provisions of Consob Reso- ment figures for 2009 have been restated on a compara- lution No. 15519 of July 27, 2006 in regard to the formats ble consolidation basis. of financial statements and Consob Notice No. 6064293 of July 28, 2006 in regard to corporate disclosure. SCOPE OF CONSOLIDATION The consolidated financial statements at December 31, 2010 consist of the Balance Sheet, the Income Statement, The scope of consolidation includes subsidiaries, associ- the Statement of Comprehensive Income, the Statement ates and investments in joint ventures. of Changes in Equity, the Cash Flow Statement and the All companies and entities whose financial and operat- Explanatory Notes, and are accompanied by the Direc- ing policies are subject to control by the Group are con- tors’ Report on Operations. sidered subsidiaries. This condition is normally satisfied The format adopted for the Balance Sheet classifies as- when the Group owns more than half of the voting rights. sets and liabilities as current and non-current. The financial statements of subsidiaries are included in The Group has opted to present the components of profit the consolidated financial statements beginning on the or loss for the year in a separate income statement, rather date when control is acquired until the time when control Consolidated financial statements 97

is lost. Non-controlling interests in Equity and net in- • the non-controlling interest in Equity and in income (loss) are separately indicated on the consolidated come (loss) is presented separately on the Bal- Balance Sheet and Income Statement. ance Sheet and Income Statement; All companies over which the Group can exercise signifi- —— investments in associates and joint ventures are ac- cant influence (as defined by IAS 28 – Investments in counted for using the equity method, on the basis Associates) are considered associates. This influence is of which the carrying amount of the investments is normally assumed to exist if the Group holds between adjusted by: 20% and 50% of the voting power of the investee or – • the investor’s share of the post-acquisition re- even with a smaller proportion of voting rights – it has the sults of the associate or joint venture; power to participate in determining the financial and op- • the allocable amount of gains and losses recog- erating policies of the investee on the basis of particular nised directly in the Equity of the associate or legal relationships. Such relationships may take the form joint venture, in accordance with the reference of shareholders’ agreements together with other forms of accounting standards; significant exercise of governance rights. • dividends paid by the associate or joint venture; Companies in which two or more parties operate a busi- • when the Group’s share, if any, of the associ- ness under joint control on the basis of a contractual or ate’s/joint venture’s losses exceeds the carrying statutory agreement are considered joint ventures. amount of the investment in the financial statements, the carrying amount of the investment is CONSOLIDATION POLICIES eliminated and the share of any further losses is recognised in the “Provisions for liabilities and The financial statements used for consolidation purposes charges,” to the extent that the Group has a con- are those of the companies included in the scope of contractual or implicit obligation to cover the losses; solidation, prepared at the reporting date of the Parent —— profits resulting from sales made by subsidiaries to and adjusted, as necessary, in accordance with the IAS/ joint ventures or associates are eliminated in propor- IFRSs applied by the Group. tion to the share held in the acquiring entity. The financial statements expressed in foreign currencies have been translated into euro at the year-end rates for the Balance Sheet and at the average exchange rates of 3. ACCOUNTING POLICIES the year for the Income Statement, with the exception of financial statements of companies operating in high-infla- 3.1 ADOPTED ACCOUNTING STANDARDS tion countries, whose Income Statements are translated at the year-end exchange rates. Pursuant to Regulation 1606 issued by the European Parliament and the European Council in July 2002, The differences arising from the translation of opening the consolidated financial statements of the Pirelli & C. Equity at year-end exchange rates have been recognised Group have been prepared in accordance with the cur- in the reserve for translation differences, together with rent International Financial Reporting Standards (“IRF- the difference between the result for the year translated Ss”) issued by the International Accounting Standards at the year-end rate and at the average rate for the year. Board (“IASB”) and endorsed by the European Union at The reserve for translation differences is recognised in December 31, 2010, as well as the measures issued in im- the Income Statement upon disposal of the company that plementation of Article 9 of Legislative Decree 38/2005. generated the reserve. The term “IFRSs” also refers to all revised International The consolidation policies may be summarised as fol- Accounting Standards (“IAS”) and all interpretations is- lows: sued by the International Financial Reporting Interpre- —— subsidiaries are consolidated on a line-by-line basis, tations Committee (“IFRIC”), formerly known as the according to which: Standing Interpretations Committee (“SIC”). • the assets, liabilities, revenue, and costs of the fi- The consolidated financial statements have been pre- nancial statements of subsidiaries are recognised pared in accordance with the historical cost method, with in their full amounts, regardless of the percent- the exception of: age of ownership; —— derivative financial instruments, financial instru- • the carrying amount of investments is eliminated ments held for trading, and available-for-sale finan- against the underlying share of Equity; cial assets, which are measured at fair value; • the financial and operating transactions between —— financial statements of companies operating inhy- companies consolidated on a line-by-line ba- perinflationary economies, which are prepared ac- sis, including dividends distributed within the cording to the current cost method. Group, are eliminated; 98 Annual Financial Report at December 31, 2010 Volume 1

Intangible assets Goodwill is tested for impairment in order to identify any Intangible assets having finite useful lives are measured impairment losses at least annually or whenever there are at cost less accumulated amortisation and accumulated indications of an impairment loss, and is allocated to cash impairment losses. generating units for this purpose. Amortisation begins when the assets is available for use Since this is an intangible asset with an indefinite useful or capable of operating in the manner intended by the life, goodwill is not amortised. management and ceases on the date when the asset is Upon disposal of the equity investment with consequent classified as held for sale or is derecognised. Gains and loss of control, the gain or loss from that disposal includes losses resulting from the sale or disposal of an intangible the corresponding residual value of goodwill. asset are determined as the difference between the net sale proceeds and the carrying amount of the asset. trademarks and licenses Trademarks and licenses are measured at cost less ac- goodwill cumulated amortisation and accumulated impairment When a controlling interest in a company is acquired, losses. The cost is amortised over the contract period or goodwill is calculated as the difference between: the useful lives of the assets, whichever is shorter. —— the price paid plus any non-controlling interests in the acquired entity. These latter interests are meas- software ured at fair value (if this option is chosen for the ac- Software license costs, including direct incidental costs, quisition in question) or in proportion to the share are capitalised and recognised net of accumulated amor- of the non-controlling interest in the net assets of the tisation and accumulated impairment losses. Software is acquired entity; amortised over its useful life on a straight-line basis. —— the fair value of the acquired assets and liabilities. If this difference is negative, that difference is immedi- research and development ately recognised as income in the Income Statement. Research costs for new products and/or processes are ex- In the case of equity interests acquired after acquisition of pensed when incurred. a controlling interest (i.e. acquisition of non-controlling There are no development costs that satisfy the condi- interests), any positive difference between the purchase tions for capitalisation under IAS 38. cost and the corresponding fraction of acquired Equity is recognised in Equity. Likewise, the effects of disposing The useful lives of intangible assets are illustrated as fol- non-controlling interests without loss of control are also lows: recognised in Equity.

Trademarks and licenses 5 years Software from 2 to 3 years

Property, plant and equipment Property, plant and equipment are measured at cost less accumulated depreciation and accumulated impairment Property, plant and equipment are recognised at the cost losses, except for land, which is not depreciated and is of acquisition or production, including directly attribut- measured at cost less accumulated impairment losses. able incidental expenses. Depreciation is recognised starting from the month in Subsequent expenditure and the cost of replacing certain which the asset is available for use, or is potentially capa- parts of property, plant and equipment are capitalised ble of providing the economic benefits associated with it. only if they increase the future economic benefits inher- Depreciation is charged monthly on a straight-line basis ent in the affected asset. All other costs are expensed as at rates that allow depreciating the assets until the end of incurred. When the cost of replacing certain parts is capi- their useful life or, in the case of disposal, until the last talised, the carrying amount of the replaced part is recog- month of use. nised in the Income Statement. Consolidated financial statements 99

The applied depreciation rates are illustrated as follows:

Buildings 3% - 10% Plant 7% - 20% Machinery 5% - 20% Equipment 10% - 33% Furniture 10% - 33% Motor vehicles 10% - 25%

Government grants related to assets referring to property, Gains and losses resulting from the sale or disposal of plant and equipment are recognised as deferred income property, plant and equipment are determined as the dif- and credited to the Income Statement over the period of ference between the net proceeds from the sale and the depreciation of the relevant assets. carrying amount of the asset. Borrowing costs directly attributable to the purchase, construction or production of a qualifying asset are capi- Impairment of assets talised as part of the cost of the asset. A qualifying asset is one that requires substantial time in order to be ready property, plant and equipment and intangible assets for use. The capitalisation of borrowing costs ceases when Whenever there are specific indicators of impairment, substantially all the activities necessary to render the and at least annually for intangible assets with indefinite qualifying asset available for use have been completed. life, including goodwill, property, plant and equipment Leasehold improvements are classified as property, plant and intangible assets are tested for impairment. and equipment, consistently with the nature of the cost The test consists of an estimate of the recoverable amount incurred. The depreciation period corresponds to the re- of the asset and a comparison with its carrying amount. maining useful life of the asset or the residual period of The recoverable amount of an asset is the higher of its the lease agreement, whichever is shorter. fair value less costs to sell and its value in use, where the Spare parts of significant value are capitalised and de- latter is the present value of the expected future cash preciated over the estimated useful life of the assets to flows arising from the use of the asset and those deriving which they refer. from its disposal at the end of its useful life, excluding Any dismantling costs are estimated and added to the income taxes and applying a discount rate, which should cost of property, plant and equipment with a correspond- be the pre-tax rate which reflects the current market as- ing accrual to provisions for liabilities and charges if the sessments of the time value of the money and the risks prerequisites for building such provisions are satisfied. specific to the asset. They are then depreciated over the remaining useful life If the recoverable amount is lower than the asset carrying of the assets to which they refer. amount, the latter is reduced to the recoverable amount. Assets acquired under finance lease agreements, in which This reduction constitutes an impairment loss, which is substantial all the risks and rewards of ownership are trans- recognised in the Income Statement. ferred to the Group, are recognised as property, plant and In order to assess impairment, assets are allocated to the equipment at their fair value or, if lower, at the present value lowest level at which independent cash flows are sepa- of the minimum lease payments, with a corresponding entry rately identifiable (cash generating units). Specifically, for the relevant financial payable. The lease instalment pay- goodwill must be allocated to the cash generating unit or ments are allocated between interest expense, which is rec- group of cash generating units, complying with the maxi- ognised in the Income Statement, and principal repayment, mum level of aggregation allowed, which must never be which is recorded as a reduction of the financial payable. greater than the operating segment. Leases in which the lessor maintains substantially all the When there is evidence that an impairment loss recog- risks and rewards associated with ownership are classified nised in previous years and relating to property, plant as operating leases. The costs referring to an operating and equipment or intangible assets other than goodwill lease are recognised as an expense in the income state- may no longer exist or can be reduced, the recoverable ment over the lease term on a straight-line basis. amount is estimated again. If it is higher than the net carrying amount, then the net carrying amount should be in- Property, plant and equipment are derecognised at the creased to the revised estimate of its recoverable amount. time of disposal or retirement from use and, consequent- The reversal of an impairment loss may not exceed the ly, when no future economic benefits are expected to de- carrying amount that would have been recognised (net rive from their sale or use. of impairment and depreciation or amortisation) had no 100 Annual Financial Report at December 31, 2010 Volume 1

impairment loss been recognised in previous years. not held for trading. They are recognised in the Balance The reversal of an impairment loss other than goodwill is Sheet item “Other financial assets.” recognised in the income statement. They are measured at fair value, if this can be reliably An impairment loss recognised for goodwill may not be determined. reversed in subsequent years. Gains and losses deriving from changes in fair value are An impairment loss recognised for goodwill on the inter- recognised in a specific Equity reserve. im financial statements may not be reversed in the subse- When a reduction in fair value has been recognised di- quent annual period. rectly in Equity and there is objective evidence that the asset was impaired, the losses recognised up to that time investments in associates and joint ventures in Equity are recognised in the Income Statement. A For the purpose of impairment testing, the value of in- prolonged (meaning more than 12 months) or signifi- vestments in associates and joint ventures, accounted cant (meaning more than one-third) reduction in the fair for using the Equity method, must be compared with value of equity securities as compared with their cost is the recoverable amount. The recoverable amount corre- considered an indicator of impairment. sponds to the higher of the fair value, less selling costs, In the event of disposal, the gains and losses recognised up to and the value in use. There is no need to estimate both that time in Equity are recognised in the Income Statement. amounts because it is sufficient to verify that one of the Any impairment losses recognised on available-for-sale two amounts is higher than the carrying amount in order financial assets in the Income Statement cannot bere- to establish that no impairment has occurred. versed through the Income Statement. For the purposes of impairment testing, the fair value of Impairment losses recognised in the interim Financial an investment in an associate or joint venture with shares Statements on equity securities classified as available for listed on an active market is always equal to its market sale cannot be reversed to the Income Statement in the value, irrespective of the percentage of ownership. subsequent financial year. For the purpose of determining the value in use of an asso- Available-for-sale financial assets, whether debt or equity ciate or joint venture accounted for using the Equity meth- instruments for which fair value is not available, are ac- od, the following estimates should be made alternatively: counted for at cost, reduced by any impairment losses a) the share of the present value of estimated future based on the best market information available at the Bal- cash flows that are expected to be generated by the ance Sheet date. associate or joint venture, including cash flows deriv- Purchases and sales of available-for-sale financial assets ing from the operating activities of the associate or are accounted for at the settlement date. joint venture and the consideration that will be received upon final disposal of the investment (known Inventories as the discounted cash flow – asset side method); b) the present value of estimated future cash flows that Inventories are measured at the lower of cost, determined are expected to arise from dividends to be received according to the FIFO method, and their estimated real- and from final disposal of the investment (known as isable value. the dividend discount model – equity side method). The measurement of inventories includes direct costs of If there is evidence than an impairment loss recognised in materials and labour and indirect costs. Provisions are previous years may no longer exist or can be reduced, the recalculated for obsolete and slow-moving inventories, tak- coverable amount of the investment is estimated again, and if ing into account their expected future use and estimated it is higher than the amount of the investment, then the latter realisable value. The realisable value is the estimated sell- amount should be increased up to the recoverable amount. ing price, net of all costs estimated to complete the asset The reversal of an impairment loss may not exceed the and selling and distribution costs that will be incurred. amount of the investment that would have been recog- Cost includes incremental expenses and borrowing costs nised (net of impairment) had no impairment loss been qualifying for capitalisation, similarly to what has been recognised in previous years. described for property, plant and equipment. The reversal of an impairment loss on investments in associates and joint ventures is recognised in the Income Construction contracts Statement. A construction contract is a contract specifically negotiat- Available-for-sale financial assets ed for the construction of an asset, based on the instructions of a principal who, as a preliminary step, designs the The category of available-for-sale financial assets includes plans and the technical characteristics. investments in entities other than subsidiaries, associ- Contract revenues include the consideration initially ates and joint ventures and other financial instruments agreed with the customer, as well as changes in the con- Consolidated financial statements 101

struction work and price variations envisaged by the con- The impairment percentages are determined on the basis tract that can be determined reliably. of historic experience and statistical data. When the outcome of a contract can be estimated reli- When the conditions that led to impairment of the receiv- ably, the contract revenues and costs are measured using ables no longer exist, the impairment losses recognised the percentage of completion method. The stage of com- in previous periods are reversed by crediting the income pletion is determined with reference to the costs incurred statement up to the amortised cost that would have been up to the Balance Sheet date as a percentage of the total recognised had no impairment loss been recognised. estimated costs for each contract. Receivables in currencies other than the functional cur- Costs incurred in connection with future activities on rency of the individual companies are adjusted to the the contract are excluded from contract costs when year-end exchange rates, with a balancing entry in the determining the stage of completion and are recog- Income Statement. nised as inventories. Receivables are derecognised when the right to receive When total contract costs are expected to exceed total cash flows is extinguished, when substantially all the risks contract revenues, the expected loss is immediately rec- and rewards connected with holding the receivable have ognised as an expense. been transferred, or when the receivable is considered The gross amount due from customers for contract work definitely irrecoverable after all necessary credit recovery for all the contracts in progress and for which the costs procedures have been completed. When the receivable is incurred plus recognised profit (or net of recognized loss- derecognised, the relative provision is also derecognised, es) exceed progress billings is recognised as a receivable, if the receivable had previously been impaired. under the item “trade receivables.” The gross amount due to customers for contract work for Payables all the contracts in progress and for which the progress billings exceed the costs incurred plus recognised profit Payables are initially recognised at their fair value, which (or net of recognised losses) is recognised as a payable, normally corresponds to the consideration agreed or to under the item “trade payables.” the present value of the amount that will be paid. They are subsequently measured at amortised cost. Receivables Amortised cost is calculated by using the effective interest rate method, which is equivalent to the discount Receivables are initially recognised at their fair value, rate that, when applied to future cash flows, renders the which normally corresponds to the consideration agreed present value of such flows equal to the initial fair value. or to the present value of the amount that will be collected. Payables in currencies other than the functional cur- They are subsequently measured at amortised cost, less rency of the individual companies are adjusted to the provisions for impairment losses. year-end exchange rates, with a balancing entry in the Amortised cost is calculated by using the effective in- Income Statement. terest rate method, which is equivalent to the discount Payables are derecognised when the specific contractual rate that, when applied to future cash flows, renders the obligation is extinguished. present value of such flows equal to the initial fair value. Impairment losses on receivables are calculated accord- Financial assets carried at fair value through ing to counterparty default risk, which is determined by profit or loss considering available information on the solvency of the counterparty and historic data. The carrying amount of This category includes financial instruments that are receivables is reduced indirectly by building provisions. purchased mainly for resale in the short term and clas- Individual material positions that are objectively found sified under current assets as “securities held for trad- to be partially or entirely uncollectable are impaired indi- ing,” financial assets that are initially recognised at fair vidually. The amount of the impairment loss reflects the value through profit or loss, classified as “other financial estimate of future recoverable flows and the applicable assets,” and derivatives (except those designated as effec- date of collection, recovery costs and expenses, and the tive hedging instruments), classified as “derivative finan- fair value of guarantees, if any. cial instruments.” The positions that are not written down individually are They are measured at fair value with a balancing entry in included in groups with similar characteristics in terms of the Income Statement. Transaction costs are expensed to credit risk, and they are impaired on a collective basis ac- the Income Statement. cording to a percentage that increases as the period during Purchases and sales of these financial assets are account- which they are overdue increases. The group impairment ed for at the settlement date. procedure also applies to receivables not yet due. 102 Annual Financial Report at December 31, 2010 Volume 1

Cash and cash equivalents fixed price whenever specific conditions are met. In these cases, the fair value of the option, determined at Cash and cash equivalents include bank deposits, postal the grant date, is recognised as an expense in the In- deposits, cash and cash equivalents on hand. come Statement over the duration of the plan, with a corresponding entry increasing the reserves in Equity; Provisions for other liabilities and charges —— cash-settled: these are plans that provide for put options in favour of the recipient, combined with call Provisions for other liabilities and charges include accru- options in favour of the issuer, or plans where the als for current obligations (legal or constructive) deriv- recipient directly receives the monetary equivalent ing from a past event, for the fulfilment of which an out- amount of the benefit deriving from exercise of the flow of resources will probably be necessary and whose stock option. The fair value of the option, which is amount can be reliably estimated. remeasured at the end of every reporting period, is Changes in estimates are recognised in the Income State- recognised in the Income Statement over the vestment of the period when the change occurs. ing period of the plan, with a corresponding liability If the effect of discounting is material, provisions are pre- entry in the Balance Sheet. Changes in the fair value sented at their present value. of the liability subsequent to the vesting period are recognised in the Income Statement. Employee benefit obligations Derivative financial instruments designated as Employee benefits paid after termination of the employ- effective cash flow hedges ment relationship under defined benefit plans and other long-term benefits are subject to actuarial valuations. These derivative instruments are measured at fair value, in The liability recognised in the Financial Statements is accordance with IAS 39. the present value of the Group’s obligation, net of the fair In relation to such instruments, the Group formally docu- value of any plan assets. ments the relationship between the hedging instrument and With regard to defined benefit plans, the Pirelli Group the hedged item, its risk management objectives and the has elected the option allowed by IAS 19, under which strategy followed in putting in place the hedge transaction. actuarial gains and losses are fully recognised in Equity The Group also assesses the effectiveness of the hedging in the financial year when they arise. instrument in offsetting the changes in cash flows attribut- For other long-term benefits, actuarial gains and losses able to the hedged risk. This assessment is carried out at are recognised immediately in the Income Statement. hedge inception and on an on-going basis for the duration The interest cost and expected return on plan assets are of the hedge. recognised under personnel costs. The effective portion of the change in the fair value of the The costs relating to defined contribution plans are rec- derivative that was designated and qualifies as a hedging ognised in the Income Statement when incurred. instrument is recognised directly in Equity. The gain or Until December 31, 2006, the provision for post-employ- loss relating to the ineffective part is recognised in the ment benefits (TFR) of Italian companies was consid- Income Statement. ered a defined benefit plan. The rules governing this pro- The amounts recognised directly in Equity are reversed to vision were amended by Law 296 of December 27, 2006 the Income Statement when the hedged item produces an (“2007 Italian Budget Act”) and subsequent decrees and effect in the Income Statement. regulations issued in the early months of 2007. In light When a hedging instrument expires or is sold, or no longer of these changes, and specifically in reference to Group meets the criteria to be designated as a hedge, or whenever companies with more than 50 employees, the provision the Group revokes the designation, the relevant fair value ad- is now considered a defined benefit plan for the portion justments accumulated in Equity remain in Equity until the accrued prior to January 1, 2007 (and not yet paid out at hedged item produces an effect in the Income Statement. the reporting date), whereas subsequent to that date, it is Subsequently they are reclassified to the Income Statement considered a defined contribution plan. over the periods in which the acquired financial asset or assumed financial liability impact the Income Statement. Stock options When the hedged item is no longer expected to impact the Income Statement, the fair value adjustments accu- Stock options are divided into two types that require dif- mulated in Equity are immediately recognised in the In- ferent accounting treatment according to the features of come Statement. the plan: Purchases and sales of these derivative financial assets are —— equity-settled: these are plans where the grantee is giv- accounted for at settlement date. en the right to purchase shares of the company at a Consolidated financial statements 103

Determination of the fair value of financial costs of equity transactions instruments Costs that are directly attributable to Equity transactions of the Parent are recognised as a reduction in Equity. The fair value of financial instruments traded on an active market is based on listed market prices at the reporting Recognition of revenue date. The listed market price used for financial assets is the bid price, while for financial liabilities it is theask price. Revenue is measured at the fair value of the consideration The fair value of instruments that are not traded on an received for the sale of products or provision of services. active market is determined by using measurement techniques with a variety of methods and assumptions that sales of products are based on market conditions at the balance sheet date. Revenue from the sale of products is recognised when all The fair value of interest rate swaps is calculated as the the following conditions are met: present value of expected future cash flows. —— the material risks and rewards of ownership of the The fair value of forward exchange contracts is deter- goods are transferred to the buyer; mined by using the forward rate at the reporting date. —— effective control over the goods and the normal continuing level of activities associated with ownership Income taxes have ceased; —— the amount of revenue is reliably determined; Current taxes are determined on the basis of a realistic —— it is likely that the economic benefits deriving from the forecast of the taxes payable under the current tax law of sale will be enjoyed by the enterprise; the country. —— the costs incurred or to be incurred are determined Deferred taxes are calculated according to the temporary dif- reliably. ferences existing between the asset and the liability amounts If the nature and extent of involvement of the seller are in the Balance Sheet and their tax basis (full liability method), such as to cause that the risks and rewards of owner- and are classified under non-current assets and liabilities. ship are not in fact transferred, then the recognition date Deferred tax assets on tax loss carry-forwards, as well as of the revenues is deferred until the date on which this on temporary differences, are only recognised when there transfer can be considered to have taken place. is a likelihood of future recovery. Current and deferred tax assets and liabilities are offset rendering of services when the income taxes are levied by the same tax author- Revenue from the rendering of services is recognised only ity and when there is a legally enforceable right to offset. when the results of the transaction can be measured reli- Deferred tax assets and liabilities are determined accord- ably, by reference to the state of completion of the transac- ing to enacted tax rates that are expected to be application at the balance sheet date. ble to taxable income in the years when those temporary The results of a transaction can be measured reliably only differences are expected to be recovered or settled, with when all the following conditions are met: reference to the jurisdictions where the Group operates. —— the amount of revenue can be determined reliably; The deferred tax liabilities related to equity investments —— it is likely that that company will enjoy the economic in subsidiaries, associates and joint ventures are not rec- benefits of the transaction; ognised if the participating entity can control the turno- —— the stage of completion of the transaction at the re- ver of temporary differences and if it is unlikely that such porting date can be reliably measured; turnover will arise in the foreseeable future. —— the costs incurred for the transaction and the costs to Deferred taxes are not discounted. be incurred to complete it can be determined reliably. Deferred tax assets and liabilities are credited or debited to Equity if they refer to items that have been credited interest income or debited directly in Equity during the period or during Interest income is recognised on a time proportion basis previous periods. that considers the effective return of the asset.

Equity royalty income Royalty income is recognised on an accrual basis, accord- treasury shares ing to the substance of the relevant agreement. Treasury shares are recognised as a reduction in Equity. If they are sold, reissued or cancelled, the resulting gains or losses are recognised in Equity. 104 Annual Financial Report at December 31, 2010 Volume 1

dividend income one year after the classification date. Dividend income is recognised when the right to receive On the consolidated Balance Sheet, the non-current as- payment is established, which normally corresponds to the sets held for sale and the current and non-current assets/ resolution passed by the Shareholders’ Meeting for the dis- liabilities of the disposal group are presented as a separate tribution of dividends. item from other assets and liabilities, and their totals are reflected in current assets and liabilities, respectively. Earnings (losses) per share Non-current assets classified as held for sale and disposal groups are measured at the lower of their respective car- Earnings (losses) per share are calculated by dividing the rying amounts and fair value less costs to sell. income (loss) attributable to the equity holders of the The property, plant and equipment and intangible assets company by the weighted average number of outstanding classified as held for sale are not depreciated or amortised. shares during the year. To calculate diluted earnings per share, the weighted average number of outstanding shares Discontinued operations is adjusted by assuming the conversion of all shares having a potentially dilutive effect. A discontinued operation is a component that has been disposed of or classified as held for sale and that represents Operating Segments an important business unit or geographical area of activity, and pertains to a single, coordinated disposal programme. The operating segment is a part of the Group that engag- On the consolidated Income Statement for the period, the es in business activities from which it may earn revenues net income (loss) of the discontinued operations, as well as and incur expenses, whose operating results are regularly the gain or loss resulting from fair value measurement less reviewed by top management in view of making decisions costs to sell or from disposal of the assets or disposal groups about resources to be allocated to the segment and as- constituting the discontinued operation are combined in a sessing its performance, and for which discrete financial single item at the end of the income statement separately information is available. from the income (loss) from continuing operations. The cash flows for discontinued operations are shown sep- Accounting policies for hyperinflationary countries arately in the Statement of cash flows. The foregoing information is also presented for the com- Group companies operating in high-inflation countries parative period. recalculate the amounts of their non-monetary assets and liabilities in their individual Financial Statements to 3.2 ACCOUNTING STANDARDS eliminate the distorting effects caused by the loss of pur- AND INTERPRETATIONS ENDORSED chasing power of the currency. The inflation rate used for AND IN FORCE FROM JANUARY 1, 2010 implementation of inflation accounting corresponds to the consumer price index. IFRIC 12 – Service Concession Arrangements Companies operating in countries where the cumulative inflation rate over a three-year period approximates or ex- IFRIC 12 addresses private sector operators contracted ceeds 100% adopt inflation accounting and discontinue for the supply of typical public sector services (e.g. roads, it in the event that the cumulative inflation rate over a airports and energy and water distribution under conces- three-year period falls below 100%. sion arrangements). Under these arrangements, the assets Gains or losses on the net monetary position are recog- granted are not necessarily controlled by the private opera- nised in the Income Statement. tors, although the latter are responsible for constructing, The Tyre sector company based in Venezuela is the only operating or maintaining the public infrastructure. Assets Group entity operating in a hyperinflationary country. under these arrangements are not necessarily recognised as property, plant and equipment in the financial state- Non-current assets held for sale and disposal groups ments of the private operators but rather as financial assets and/or intangible assets depending on the type of service Non-current assets and disposal groups are classified as concession arrangement. Application of this interpretation held for sale if their carrying amount is recovered mainly has no impact on the consolidated Financial Statements. through sale rather than through continuing use. This occurs if the non-current asset or disposal group are availa- IFRIC 15 – Agreements for the Construction of ble for sale under current conditions and the sale is highly Real Estate probable, or if a binding programme for sale has already begun, activities to find a buyer have already commenced This interpretation provides guidance on how to deter- and it is expected that the sale will be completed within mine whether an agreement for the construction of real Consolidated financial statements 105

estate units is within the scope of IAS 11 – Construction Application of this interpretation has no impact on the Contracts or of IAS 18 – Revenue, by defining the mo- consolidated Financial Statements. ment when the revenue must be recognised. In the light of this interpretation, residential development Revision of IFRS 3 – Business Combinations comes within the scope of IAS 18 – Revenue, entailing recognition of the revenue on completion of sale. Con- This revision is part of the project for convergence with struction service work, if carried out on the basis of the US GAAP, and has the purpose of aligning the account- client’s technical specifications, comes within the scope ing treatment of business combinations. The principal of IAS 11 – Construction Contracts. changes from the previous version are: Application of this interpretation has no impact on the —— recognition in the Income Statement – when in- consolidated Financial Statements. curred – of expenses relating to business combination transactions (legal, advisory, valuation, audit IFRIC 16 – Hedges of a Net Investment in a and professional fees in general); Foreign Operation —— the option of recognising non-controlling interests at fair value (i.e. full goodwill); this option may be cho- This interpretation clarifies certain issues relating to the sen for each individual business combination; accounting treatment, in the consolidated Financial State- —— specific rules applicable to recognition of step ac- ments, of hedges of net investments in foreign operations, quisitions: in the case of acquisition of control of an specifying which types of risks qualify for application of entity in which a non-controlling interest is already hedge accounting. In particular, it states that hedge ac- held, the investment held previously must be meas- counting is only applicable to exchange rate differences aris- ured at fair value through profit or loss; ing between the functional currency of the foreign entity —— contingent consideration, i.e. the obligations of the and the functional currency of the Parent, and not between acquirer to transfer additional assets or shares to the the functional currency of the foreign entity and the pres- seller if certain future events occur or specific condi- entation currency of the consolidated financial statements. tions are fulfilled, should be recognised and meas- Application of this interpretation has no impact on the ured at fair value at the acquisition date. Subsequent consolidated Financial Statements. changes in the fair value of these agreements are normally recognised in the Income Statement. IFRIC 17 – Distributions of Non-cash Assets to The introduction of this new standard has had no impact Owners on the Group Financial Statements.

This interpretation clarifies that: Amendments to IAS 27 – Consolidated and —— dividend payables should be recognised when the Separate Financial Statements dividend is appropriately authorised and is no longer at the discretion of the entity; The revision of IFRS 3 – Business Combinations also re- —— dividend payables should be measured at the fair sulted in amendments to IAS 27 – Consolidated and Sepa- value of the net assets to be distributed; rate Financial Statements. These are summarised as follows: —— the difference between the dividends paid and the —— changes in a Parent’s ownership interest in a sub- carrying amount of the net assets distributed should sidiary that do not result in the loss of control are be recognised in the Income Statement. accounted for as equity transactions. In other words, Assignment to shareholders of the equity investment in the difference between the price paid/received and Pirelli RE (now Prelios), which was completed on Oc- the share of net assets acquired/sold must be recog- tober 25, 2010, has been recognised in compliance with nised in Equity; this interpretation, as mentioned in note 38 elsewhere in —— if control of a subsidiary is lost, but a non-controlling this report. interest in it is retained, this interest must be measured at fair value at the date on which the loss of IFRIC 18 – Transfers of Assets from Customers control occurs. The introduction of this new standard has had no mate- This interpretation is particularly significant for compa- rial impact on the Group Financial Statements. nies operating in the utilities sector and clarifies the rules applicable to agreements under which an entity receives Amendment to IAS 39 – Financial Instruments: from a customer an asset that the entity uses to connect Recognition and Measurement – eligible hedged the customer to a network or to ensure the customer on- items going access to the provision of goods and services (e.g. electricity, water or gas). This amendment illustrates and clarifies what may be 106 Annual Financial Report at December 31, 2010 Volume 1

designated as a hedged item in certain specific situations: existing standards that made it less clear. The latest revi- —— designation of a one-sided risk in a hedged item, i.e. sion of IFRS 1 has not resulted in any substantial changes when only changes in cash flow or fair value over or from its previous version, but it has modified its structure. below a certain value, instead of the total change, are This standard has no impact on the Group financial designated as a hedged item; statements. —— designation of inflation as a hedged item. Application of this interpretation has no impact on the “Improvements” to IFRSs (issued by the IASB in Group Financial Statements. April 2009)

Revised IFRS 1 – First-time Adoption of As part of the project begun in 2007, the IASB has issued International Financial Reporting Standards a series of amendments to twelve current standards.

IFRS 1 has been revised several times over the years, The following table summarises the standards and issues following the issue of new standards or amendments to addressed by these amendments:

IFRS Subject of the amendment IFRS 2 – Share-based Payment Scope of application of IFRS 2 and revised IFRS 3 IFRS 5 – Non-current Assets Held for Sale and Disclosure of non-current assets (or disposal groups) classified as held for sale or discon- Discontinued Operations tinued operations IRFS 8 – Operating Segments Disclosure of activities of operating segments IAS 1 – Presentation of Financial Statements Classification of convertible instruments as current / non-current IAS 7 – Cash Flow Statements Classification of expenditures on unrecognised assets IAS 17 – Leases Classification of leases of land and building IAS 18 - Revenue Definition of characteristics useful for determining whether an entity acts as an agent (e.g. is not exposed to the significant risks and rewards of a transaction) or on its own behalf (e.g. it is exposed to the significant risks and rewards of a transaction) IAS 36 – Impairment of Assets Dimension of the cash generating unit for carrying out the impairment test on goodwill IAS 38 – Intangible Assets —— Additional amendments resulting from revision of IFRS 3 —— Fair value measurement of an intangible asset acquired through a business combination IAS 39 – Financial Instruments: Recognition and —— Fair value measurement of an intangible asset acquired through a business combina- Measurement tion —— Scope exemption for business combination agreements —— Cash flow hedge accounting IFRIC 9 – Reassessment of Embedded Derivatives Scope of IFRIC 9 and revised IFRS 3 IFRIC 16 – Hedges of a Net Investment in a Amendment to the restriction on the entity that may hold hedge instruments Foreign Operation

Application of these amendments has had no material quan- Financial Statements insofar as they are not applicable to titative impact on the Group Financial Statements. the Group.

Amendments to IFRS 2 – Share-based Payment Amendments to the revised IFRS 1 – First-time Adoption of International Financial Reporting These amendments aim to clarify the accounting treat- Standards – additional exemptions in the case of ment of cash-settled stock option plans in the Financial first-time adoption Statements of a subsidiary, if benefits are paid to employees by the Parent or a Group entity other than the one These changes govern the retrospective application of IFRSs where the employee works. These amendments also in- in certain cases, and are intended to avoid excessive costs clude guidelines previously set out in IFRIC 8 “Scope of and effort during the transition to IFRSs. IFRS 2” and IFRIC 11 “IFRS 2 – Group and Treasury These amendments have had no impact on the Group con- Share Transactions,” which have been abrogated. solidated Financial Statements. The amendments to IFRS 2 have no impact on the Group Consolidated financial statements 107

3.3 INTERNATIONAL ACCOUNTING Amendments to IFRIC 14 – Prepayments of a STANDARDS AND/OR INTERPRETATIONS Minimum Funding Requirement THAT HAVE BEEN ISSUED BUT NOT YET IN FORCE AND/OR ENDORSED The amendments to IFRIC 14 govern the rare case where an entity that is subject to minimum funding requirements Pursuant to IAS 8 – Accounting Policies, Changes in Account- for defined benefit plans makes prepayments to guarantee ing Estimates and Errors, the new standards and/or interpre- compliance with these requirements. The benefits resulting tations that have been issued but are not yet in force or not yet from prepayments may be recognised as assets. endorsed by the European Union, and which are therefore The amendments to IFRIC 14 were endorsed by the Euro- not applicable, are mentioned and described briefly as follows. pean Union in July 2010 (EC Regulation 633/2010) and are None of these standards and interpretations has been early applicable from January 1, 2011. These amendments do not adopted by the Group. apply to the Group.

Amendments to IAS 32 – Financial Instruments: IFRIC 19 – Extinguishing Financial Liabilities with Disclosure and Presentation – classification of rights Equity Instruments issues This interpretation provides guidelines on how to account The amendments address rights issues, such as warrants and for the extinguishing of a financial liability through the issue similar rights, that are denominated in a currency other than of equity instruments (debt for equity swap), i.e. when an the issuer’s functional currency. Previously, these rights issues entity renegotiates the terms of a debt with its lender, which were recognised as derivative financial liabilities. Now, if cer- agrees to receive shares in the entity or other equity instru- tain conditions are satisfied, these rights issues may be classi- ments to settle the debt in full or in part. fied as Equity instruments, regardless of the currency in which This interpretation clarifies that: the exercise price is denominated. —— the shares issued are part of the consideration paid to These amendments were endorsed by the European Union extinguish the financial liability; in December 2009 (EC Regulation 1293/2009) and are ap- —— the shares issued are carried at fair value. If the fair value plicable from January 1, 2011. It is not expected that future cannot be determined reliably, the equity instruments application of these amendments will have any impact on the issued must be measured in such a way as to reflect the Group Financial Statements. fair value of the liability that is extinguished; —— the difference between the carrying amount of the fi- Amendments to revised IFRS 1 – First-time Adoption nancial liability being extinguished and the initial value of International Financial Reporting Standards – of the shares issued must be recognised by the entity in limited exemptions from the comparative disclosure the income statement for the period. required under IFRS 7 upon first-time adoption This interpretation was endorsed by the European Union in July 2010 (EC Regulation 662/2010) and is applicable from This amendment grants an exemption from having to provide January 1, 2011. Future application of this interpretation is the additional comparative disclosure data required under not expected to have any impact on the Group Financial IFRS 7 regarding the measurement of fair value and liquidity Statements. risk upon first-time adoption of IFRSs. These amendments were endorsed by the European Union IFRS 9 – Financial Instruments in June 2010 (EC Regulation 574/2010) and are applicable from January 1, 2011. They will have no impact on the Group IFRS 9 represents the completion of the first of three stages consolidated Financial Statements. of the planned replacement of IAS 39 – Financial State- ments: Recognition and Measurement, which has the prin- Revised IAS 24 – Related Party Disclosures cipal aim of reducing its complexity. In the version issued by the IASB in November 2009, the scope of IFRS 9 was The revised IAS 24 simplifies the disclosures requirements restricted to financial assets only. In October 2010 the IASB regarding related parties when state-controlled entities are amended IFRS 9 by adding the requirements for classifica- involved and provides a new, simplified and more coherent tion and measurement of financial liabilities, thereby com- definition of related parties. pleting the first phase of the project. This standard was endorsed by the European Union in July The second stage of the project, concerning the impairment 2010 (EC Regulation 632/2010) and is applicable from Janu- of financial instruments, and the third stage, concerning ary 1, 2011. It is not expected that future application of this hedge accounting, led to the issue of two Exposure Drafts standard will have any material impact on Group disclosures. in November 2009 and December 2010, respectively. It is 108 Annual Financial Report at December 31, 2010 Volume 1

expected that the final standards will be issued in the second classified from Equity to the Income Statement (either quarter of 2011. in the event of impairment or in the event of sale). Divi- The principal changes introduced by IFRS in regard to fi- dends instead continue to be recognised in the Income nancial assets can be summarised as follows: Statement; —— financial assets may be classified in only two categories, —— IFRS 9 does not allow reclassifications between the two at fair value or at amortised cost. The categories of loans categories of financial assets except in rare cases where and receivables, available-for-sale financial assets and -fi there is a change in the entity’s business model. In this nancial assets held to maturity are therefore eliminated. case, the effects of the reclassification are applied pro- Classification within the two categories is made on the spectively; basis of the entity’s business model and on the basis of —— the disclosure required in the notes has been adapted the features of the cash flows generated by the assets to the classification and measurement rules introduced themselves. Financial assets are measured at amortised by IFRS 9. cost if both the following requisites are met: the entity’s In regard to financial liabilities, the IASB has substantially business model envisages that financial assets are held confirmed the provisions of IAS 39, except for the require- to collect their cash flows (thus, substantially, not to ments applicable to the fair value option. When the fair value make trading profits) and the characteristics of the cash option is adopted for financial liabilities, the change in fair flows of the assets correspond only to payment of prin- value attributable to the change in the issuer’s credit risk cipal and interest. Otherwise, financial assets must be must be recognised in the Statement of comprehensive in- measured at fair value; come and not in the Income Statement. —— the accounting rules for embedded derivatives have The process of endorsement of IFRS 9, which will come into been simplified: separate accounting for the embedded force on January 1, 2013, has been temporarily suspended. derivative and the “host” financial asset is no longer re- It is currently impossible to quantify the impact resulting quired; from future application of this standard to the classification —— all equity instruments – both listed and unlisted – must and measurement of financial assets. The changes affecting be measured at fair value. IAS 39 stated instead that financial liabilities are not applicable to the Group. if fair value could not be determined reliably, unlisted equity instruments had to be measured at cost; “Improvements” to IFRSs (issued by the IASB in —— the entity has the option of presenting in Equity any May 2010) change in the fair value of equity instruments not held for trading, while this option is forbidden for those held As part of the project begun in 2008, the IASB has issued a for trading. This designation is permitted at the time of series of amendments to eight current standards. initial recognition, may be adopted for a single financial The following table summarises the standards and issues ad- instrument and is irrevocable. If this option is taken, the dressed by these amendments: fair value changes of such instruments can never be re-

IFRS Argomento della modifica IFRS 3 – Business Combinations —— Transitional provisions regarding contingent consideration for business combinations completed before 01/01/2010 —— Measurement of non-controlling interests at the acquisition date —— Impact of business combinations on accounting of share-based payments IFRS 7 – Financial Instruments: Disclosures Clarification in regard to the disclosures to be published for each class of financial assets IAS 1 – Presentation of Financial Statements Clarifications regarding the schedule of changes in Equity IAS 27 – Consolidated and Separate Financial Transitional provisions for amendments to certain standards resulting from the changes Statements introduced by IAS 27 (2008): —— IAS 21 – Effects of changes in foreign exchange rates: accounting of translation differences accumulated in Equity following total or partial sale of an investment in a foreign entity —— IAS 28 – Investments in Associates/IAS 31 – Interests in Joint Ventures: accounting treatment if significant influence or joint control are lost IAS 34 – Interim Financial Reporting Disclosures required by IFRS 7 – Financial Instruments: Disclosures and its applicability to Interim Financial Statements IFRIC 13 – Customer Loyalty Programmes Fair value of award credits Consolidated financial statements 109

These amendments were endorsed by the European to reconstruct transactions that occurred before first- Union in February 2011 (EC Regulation 149/2011) and time adoption of IFRSs and that led to derecognition of are applicable from January 1, 2011. It is not expected financial assets and liabilities. that they will have a material impact on the Group con- These amendments, which are expected to come into solidated Financial Statements. force on July 1, 2011, have not yet been endorsed by the European Union and are not applicable to the Group. Amendments to IFRS 7 – Financial Instruments: Disclosures 4. FINANCIAL RISK These amendments seek to improve Financial State- MANAGEMENT POLICIES ment disclosure and consequently improve the transparency and comparability of transactions involving the Financial risk management is an integral part of man- transfer of financial assets (e.g. securitisations), includ- aging the Group’s business. It is carried out centrally in ing the possible effects of risks for which the transferor accordance with guidelines issued by the Finance De- remains liable. partment on the basis of general risk management strate- These amendments, which are expected to come into gies defined by the Managerial Risk Committee. These force on July 1, 2011, have not yet been endorsed by the guidelines define the risk categories and specify the ap- European Union. It is not expected that they will impact plicable operating procedures and limits for each type of the Group consolidated Financial Statements. transaction and/or instrument. In accordance with these guidelines, the Group uses derivative contracts in rela- Amendments to IAS 12 – Income Taxes – Deferred tion to underlying financial assets or liabilities or future Taxes: recovery of underlying assets transactions. Within the Finance Department, financial risk management is centralised at the Group Treasury, IAS 12 requires measurement of deferred taxes related which is responsible for assessing risks and implementing to an asset or liability according to whether the book hedges against them. The Group Treasury acts directly value of the asset is recovered through use or through on the market on behalf of the Business Units and, when sale. In the case of assets carried at fair value pursuant external constraints prevent it from acting directly, coor- to IAS 40 – Investment Property, determining whether dinates the operations of the Local Treasury Units. recovery is realised through use or sale might be difficult and subjective. These changes offer a practical solution TYPES OF FINANCIAL RISKS to the problem, by allowing one to assume that investment property will be recovered entirely through sale. Exchange rate risk Consequently, SIC 21 – Income Taxes - Recovery of Re- valued Non-Depreciable Assets is no longer applicable The varied geographical distribution of Group produc- to investment property carried at fair value. The guide- tion and commercial activities entails exposure to transac- lines of SIC 21 that are still applicable have been incor- tion exchange rate risk and translation exchange rate risk. porated in the amended version of IAS 12, and SIC 21 will consequently be abrogated. a) transaction exchange rate risk These amendments, which are expected to come into This risk is generated by the commercial and finan- force on July 1, 2012, have not yet been endorsed by the cial transactions executed in currencies other than the European Union and are not applicable to the Group. functional currency due to exchange rate fluctuations between the time when the commercial or financial rela- Amendments to IFRS 1 – First-time Adoption of tionship is established and when the transaction is com- International Financial Reporting Standards – pleted (collection or payment). Hyperinflation and elimination of fixed dates on The Group aims to minimise the impact of transac- first-time adoption tion exchange rate risk on income statement. To do so, Group procedures make the operating units responsible The amendments that have been introduced concern: for collecting complete information about the assets and guidelines for preparing the Financial Statements in ac- liabilities that are subject to transaction exchange rate cordance with IFRSs after a period when application of risk. This risk is hedged with forward contracts negoti- IFRSs was suspended due to hyperinflation; ated with the Group Treasury. elimination of fixed dates upon first-time adoption of The items subject to exchange rate risk are mainly rep- IFRSs. The entities that adopt IFRSs apply the require- resented by receivables and payables denominated in ments applicable to prospective derecognition of finan- foreign currency. cial assets and liabilities, i.e. they are no longer obligated The Group Treasury is responsible for measuring and 110 Annual Financial Report at December 31, 2010 Volume 1

managing the net position for each currency. In accordance b) translation exchange rate risk with established guidelines and restrictions, it closes all risk The Group owns controlling interests in companies that positions by trading derivative hedging contracts on the prepare their financial statements in currencies other market, which typically take the form of forward contracts. than the euro, which is the Group presentation curren- The Group has decided not to adopt hedge accounting cy. This exposes the Group to translation exchange rate pursuant to IAS 39, insofar as representation of the effects risk, which is generated by the conversion of assets and of the transaction exchange risk hedging strategy in the in- liabilities of those subsidiaries into euro. come statement and in equity is substantially guaranteed The principal exposures to translation exchange rate even without adopting hedge accounting. risk are monitored, but the Group has no policy to Furthermore, as part of the annual and three-year plan- hedge this exposure. ning process, the Group makes exchange rate forecasts About 35% of total consolidated equity at December according to these time horizons by using the best in- 31, 2010 was expressed in euro (about 54% at Decem- formation available on the market. The fluctuation in ex- ber 31, 2009). The most important currencies for the change rates between the time when the forecast is made Group other than the euro are the Brazilian Real (25%; and the time when the commercial or financial transac- 19% at December 31, 2009) and the Turkish Lira (10%; tion is established represents the transaction exchange 8% at December 31, 2009). rate risk on future transactions. The table below shows the effects on total consolidated In accordance with established policy, the Group moni- Equity deriving from a hypothetical appreciation/depre- tors the opportunity to hedge future transactions, with ciation of the above currencies against the euro, with all each hedge being authorised by the Finance Depart- other conditions being equal: ment on a case-by-case basis. Hedge accounting in accordance with IAS 39 is used when the conditions for doing so are satisfied.

(in thousands of euro) Appreciation of 10% Depreciation of 10% 12/31/2010 12/31/2009 12/31/2010 12/31/2009 Brazilian Real 55,967 50,922 (45,791) (41,664) Turkish Lira 22,989 21,878 (18,809) (17,900) Total out of consolidated Equity 78,956 72,800 (64,600) (59,564)

Interest rate risk the Finance Department in order to maintain this target ratio. For such derivatives hedge accounting is adopted, Interest rate risk is the risk that the fair value or the future when conditions set by IAS 39 are met. cash flows of a financial asset or liability will change due to fluctuations in market interest rates. The table below shows the effects on net income (loss) Group policy is to attempt to maintain the following ratio and direct effects on total equity deriving from an in- between fixed rate and variable rate exposures: 65% fixed crease or decrease of 0.50% in the level of interest rates and 35% variable. of all currencies to which the Group is exposed – all other The Group makes derivative contracts, typically interest conditions being equal: rate swaps with hedging objective that are authorised by

(in thousands of euro) +0,50% -0,50% 12/31/2010 12/31/2009 12/31/2010 12/31/2009 Impact on net income (loss): —— companies consolidated line-by-line (388) (1,355) 388 1,339 —— companies accounted for by the Equity method* - (2,682) - 3,273 Total (388) (4,037) 388 4,612

Direct impact on Equity: —— companies consolidated line-by-line 8,488 9,027 (15,502) (16,552) —— companies accounted for by the Equity method* - 5,844 - (6,037) Total 8,488 14,871 (15,502) (22,589)

* Related to discontinued operations Consolidated financial statements 111

Price risk associated with financial assets The Group does not have significant concentrations of credit risk. The Group’s exposure to price risk is limited to the vola- The disclosure related to the maximum credit expo- tility of financial assets such as listed and unlisted equities sure, which is represented by the gross receivables, is and bonds, for approximately 7% of total consolidated as- included in the note 13 “Trade receivables” and 14 sets at December 31, 2010 (5.8% at December 31, 2009). “Other receivables”. Such assets are classified as available-for-sale financial -as sets or financial assets held for trading. Liquidity risk The available-for-sale financial assets, represented by equities, represent 33.2% of all financial assets subject to Liquidity risk represents the risk that the company’s avail- price risk (43.1% at December 31, 2009). A 1% change in able financial resources be insufficient to meet its finan- the aforementioned listed securities, all else being equal, cial and commercial obligations pursuant to the contrac- would entail a change of euro 1,306 thousand (euro 1,619 tual terms and conditions. thousand at December 31, 2009) in the Group’s equity. The principal tool used by the Group to mitigate liquidity risk is a meticulous financial planning process to forecast Credit risk its funding requirements exactly. This process entails that every operating company prepare three-year and one-year Credit risk represents Group exposure to contingent plans, as well as monthly treasury plans that are consoli- losses resulting from default by commercial and financial dated at the Group level. The differences between plans counterparties. and actual figures are constantly analysed. The Group is exposed to credit risk as part of its operat- Then, the Group holds cash and cash equivalents and/ ing activities and financing activities. or highly liquid short-term financial instruments and, in To limit commercial counterparty default risk, the Group particular, committed revolving credit facilities that are has implemented procedures to evaluate its customers’ adequate in terms of their amount and duration. The potential and financial solidity, monitor expected incom- typical flexibility of this type of credit facility is perfectly ing cash flows and take credit recovery action if necessary. suited to the dynamic nature of the business. The aim of these procedures is to define customer credit The Group also monitors the possibility of tapping the limits. Further sales are suspended when those limits are capital markets. In order to optimise the management of exceeded. financial resources and thus further limit liquidity risk, In some cases customers are asked to provide guarantees. the Group has implemented a centralised cash pooling These are mainly bank guarantees, issued by parties with system for the management of collection and payment the highest credit standing, or personal guarantees. Less flows in compliance with various local currency and tax frequently, mortgage guarantees may be requested. laws. Short-term and long-term bank credit facilities are Insurance policies are another instrument used to man- negotiated and managed centrally, partly in view of max- age commercial credit risk. These policies aim to prevent imising the economic benefits for the Group. the risk of non-payment through careful selection of cov- At December 31, 2010 the Group had, besides cash and ered customers in collaboration with the insurance com- cash equivalents and securities held for trading of euro pany, which undertakes to indemnify the Group in the 454,495 thousand, unused committed credit facilities of event of customer insolvency. euro 1,220,000 thousand (euro 819,000 thousand at De- The Group deals only with highly rated financial coun- cember 31, 2009), with the following maturities: terparties for the management of temporary surplus cash or for trading in derivatives.

(in thousands of euro) 12/31/2010 12/31/2009 2011 20,000 155,000 2012 - 664,000 2015 1,200,000 - 1,220,000 819,000 112 Annual Financial Report at December 31, 2010 Volume 1

The maturities of financial liabilities at December 31, 2010 can be broken down as follows:

(in thousands of euro) within 1 year 1 to 2 years 2 to 5 years over 5 years Total Trade payables 1,066,361 - - - 1,066,361 Other payables 403,373 3,243 34,773 3,648 445,037 Derivative financial instruments 69,914 - - - 69,914 Borrowings from banks and other financial institutions 247,515 146,833 624,967 122,911 1,142,226 1,787,163 150,076 659,740 126,559 2,723,538

Use of the syndicated credit facility (granted to Pirelli Tyre S.p.A. and Pirelli International Limited) of euro 380,000 thousand at December 31, 2010 has been classified under non-current borrowings from banks and other lenders due after 2014 (from 2 to 5 years). See note 24. The maturities of financial liabilities at December 31, 2009 can be broken down as follows:

(in thousands of euro) within 1 year 1 to 2 years 2 to 5 years over 5 years Total Trade payables 987,873 - - - 987,873 Other payables 491,035 19,141 8,939 5,928 525,043 Derivative financial instruments 76,153 - - - 76,153 Borrowings from banks and other financial institutions 289,305 149,972 1,248,383 107,450 1,795,110 1,844,366 169,113 1,257,322 113,378 3,384,179 Consolidated financial statements 113

Additional information: categories of financial assets and liabilities

The table below shows the carrying amounts for each class of financial asset and liability identified by IAS 39:

(in thousands of euro) Note Carrying amount at Carrying amount at 12/31/2010 12/31/2009 FINANCIAL ASSETS Financial assets carried at fair value through profit or loss Held for trading Securities held for trading 17 209,770 161,024 Current derivative financial instruments 27 33,454 26,567 Loans and receivables Non-current other financial assets 11 - 6,755 Non-current other receivables 14 315,531 557,230 Current trade receivables 13 681,181 735,792 Current other receivables 14 174,982 197,144 Cash and cash equivalents 18 244,725 632,113 Available-for-sale financial assets Non-current other financial assets 11 185,267 221,351 Hedging financial instruments Current derivative financial instruments 27 1,705 - 1,846,615 2,537,976

FINANCIAL LIABILITIES Financial liabilities carried at fair value through profit or loss Held for trading Current derivative financial instruments 27 41,896 52,408 Financial liabilities carried at amortised cost Non-current borrowings from banks and other financial institutions 24 894,711 1,505,805 Non-current other payables 26 41,664 34,008 Current borrowings from banks and other financial institutions 24 247,515 289,305 Current trade payables 25 1,066,361 987,873 Current other payables 26 403,373 491,035 Hedging financial instruments Current derivative financial instruments 27 28,018 23,745 2,723,538 3,384,179 114 Annual Financial Report at December 31, 2010 Volume 1

Additional information: fair value hierarchy ferred to at the preceding sub-indent, and that are observable on the market either directly (as in the The classification of financial instruments carried at fair case of prices) or indirectly (because they are derived value on the basis of a hierarchy of levels pursuant to from prices); IFRS 7 is illustrated as follows. This hierarchy reflects the —— Level 3 – inputs that are not based on observable significance of the inputs used to determine fair value. market data. The following levels are distinguished: —— Level 1 – unadjusted quotations recorded on an ac- The following table shows assets and liabilities carried at tive market for the assets or liabilities to be measured; fair value at December 31, 2010, divided into the three —— Level 2 – inputs different from the quoted prices re- levels defined above:

(in thousands of euro) Note Carrying amount at Level 1 Level 2 Level 3 12/31/2010 FINANCIAL ASSETS: Financial assets carried at fair value through profit or loss Held for trading Securities held for trading 17 209,770 11,910 197,860 - Current derivative financial instruments 27 33,454 - 33,454 - Hedging financial instruments Current derivative financial instruments 27 1,705 - 1,705 - Available-for-sale financial assets Other financial assets Equities 171,969 115,724 15,641 40,604 Closed-end real estate funds 13,298 48 13,250 - 11 185,267 115,772 28,891 40,604

FINANCIAL LIABILITIES: Financial liabilities carried at fair value through profit or loss Held for trading Current derivative financial instruments 27 (41,896) - (41,896) - Hedging financial instruments Current derivative financial instruments 27 (28,018) - (28,018) -

The situation at December 31, 2009 was as follows:

(in migliaia di euro) Note Carrying amount at Level 1 Level 2 Level 3 12/31/2009 FINANCIAL ASSETS: Financial assets carried at fair value through profit or loss Held for trading Securities held for trading 17 161,024 53,709 107,315 - Current derivative financial instruments 27 26,567 - 26,567 - Available-for-sale financial assets Other financial assets Equities 213,576 143,426 18,983 51,167 Closed-end real estate funds 7,775 5,461 2,314 - 11 221,351 148,887 21,297 51,167

FINANCIAL LIABILITIES: Financial liabilities carried at fair value through profit or loss Held for trading Current derivative financial instruments 27 52,408 - 52,408 - Hedging financial instruments Current derivative financial instruments 27 23,745 - 23,745 - Consolidated financial statements 115

During 2010, there were no transfers from level 1 to level The following table shows the changes that occurred in 2 or vice-versa. level 3 during 2010:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 51.167 104.235 Change in scope of consolidation - (3.665) Discontinued operations (2.781) - Subscription of capital 1.848 2.758 Disposals - (47.593) Impairment (5.743) (761) Adjustment to fair value through Equity (4.087) (2.287) Other changes 200 (1.520) Closing balance 40.604 51.167

During the year, there were no transfers from level 3 to vested capital: the indicator represents the capacity other levels or vice-versa. of business results to remunerate net invested capital, construed as the sum of non-current assets and net working capital. The Group’s objective is for this 5. CAPITAL MANAGEMENT ratio to be greater than the weighted average cost of POLICIES capital (WACC); 2. Gearing: this is calculated as the ratio between net financial position / and equity. It is an indicator of The Group’s objective is to maximise the return on net the sustainability of the ratio between debt and eq- invested capital while maintaining the ability to operate uity, which takes into account the market situation over time, ensuring adequate returns for its shareholders and trend in the cost of capital and debt at different and benefits for the other stakeholders, with a sustainable times; financial structure. 3. R.O.E (return on equity): this is calculated as the ra- In order to achieve these objectives, as well as pursue sat- tio between net income (loss) and the average book isfactory economic results and generate cash flows, the value of equity. It is an indicator representing the Group may adjust its dividend policy and the configura- Group’s ability to remunerate its shareholders. The tion of the Company’s capital. objective is for the indicator to be higher than the rate of return on a risk-free investment, correlated to The main indicators used by the Group to manage its the nature of the operated businesses. capital are: 1. Ratio between operating income and average net in- The figures for 2010 and 2009 are shown below:

2010 2009 1 Ratio between operating income and average net invested capital 11.49% 6.32% 2 Gearing 0.22 0.21 3 R.O.E. (Return on Equity) 0.19% (0.93%) 116 Annual Financial Report at December 31, 2010 Volume 1

6. ESTIMATES AND Goodwill ASSUMPTIONS In accordance with the accounting standards adopted for The preparation of the consolidated financial statements preparation of the financial statements, goodwill is tested entails that management make estimates and assump- annually in order to ascertain the existence of any impair- tions which, under certain circumstances, are based on ment losses to be recognised in the income statement. In difficult and subjective assessments and estimates that particular, the test in question entails allocation of goodwill are based on historical experience, and assumptions to cash generating units and subsequent determination of which are periodically considered reasonable and realis- their recoverable amount, understood as the greater of fair tic in light of the circumstances. The results that actually value and value in use. emerge could therefore differ from such estimates. Es- If the recoverable amount proves to be less than the car- timates and assumptions are reviewed regularly and the rying amount of the cash generating units, the goodwill effects of each change made to them are recognised in allocated to them must be impaired. Determination of the the income statement of the year when the estimate is re- recoverable amount of the cash generating units entails vised if the revision itself only affects that year, or also in using estimates that depend on subjective assessments subsequent periods if the revision affects both the current and on factors that can change over time, with conse- period and future ones. quent and possibly material effects on the measurements In this context it is important to note that the situation made by management. caused by the current economic and financial crisis has entailed making extremely uncertain assumptions about Impairment of property, plant and equipment and future performance. Therefore, it cannot be ruled out that intangible assets next year’s results will be different from those estimated and that adjustments to the carrying value of the relevant In accordance with the reference accounting standards, items might be necessary, including significant adjust- non-current assets are tested to ascertain whether there ments, which obviously cannot be estimated or foreseen has been an impairment loss, which must be recognised at this time. Such estimates affect the carrying amounts through impairment, when there are signs that difficulties of certain assets and liabilities, costs and revenues, and are to be expected for recovery of their net carrying amount also disclosures relating to contingent assets/liabilities at through use. Testing whether these symptoms exist requires the reporting date. that the directors use subjective assessments based on infor- The estimates and assumptions relate mainly to assess- mation available from both internal and external sources, ments of the recoverability of intangible assets, to the and on historical experience. Moreover, if it is determined definition of the useful lives of property, plant and equip- that a potential impairment loss may be generated, this loss ment, to the recoverability of receivables and to the rec- is calculated using appropriate measurement techniques. ognition/measurement of provisions, pension schemes The proper identification of elements indicating the exist- and other post-employment benefits and are based on ence of a potential impairment loss, and the estimates for data that reflect the current state of available knowledge calculating the amount of such losses, depend on subjective assessments and factors that may vary over time, affecting Estimates entailing greater subjectivity the assessments and estimates made by management. and having a particularly material impact Pension plans and other post-employment benefits

What follows is a brief description of the accounting poli- Group companies have set up pension plans, healthcare cies that, more than others, require management to ex- plans and other defined benefit plans in different coun- ercise greater subjectivity in the calculation of estimates, tries for their employees, mainly in the United States, the and for which a change in the conditions underlying the United Kingdom and Italy. assumptions used could have a material impact on the Management uses different actuarial assumptions to cal- Consolidated Financial Statements, or for which there is culate the liabilities and the future returns on plan as- a risk that material adjustments to the carrying amount of sets related to these employee benefit plans. Actuarial as- assets and liabilities may emerge in the year subsequent sumptions of a financial nature regard the discount rate, to the reference period. the expected return on plan assets, the rates of future salary increases and trends in healthcare costs. Demographic actuarial assumptions essentially regard the rates of mortality, disability and resignations. The Group has identified discounting rates deemed to be balanced, considering the context. Consolidated financial statements 117

Deferred taxes mate entails making assumptions that depend on factors that may change over time and which could there- Deferred tax assets are accounted for on the basis of ex- fore have a material impact with respect to the current pected future income expectation. The measurement of estimates made by management for preparation of the prospective income to account for deferred taxes depends Consolidated Financial Statements. on factors that may change over time and materially impact the measurement of deferred tax assets. The determination of adjustment items reflects budget 7. OPERATING SEGMENTS figures and plans consistent with those used for the impairment tests and described in the previous paragraph in The Tyre segment is the only operating segment for relation to the recoverable amount of non-current assets. which separate information has been reported at De- It is also believed that the adjustment items are sufficient cember 31, 2010. to cover the risk of a further worsening of the assumptions of the plan, taking into account the fact that the net The structure of the operating segments reflects the or- deferred tax assets accrued in this way relate to tempo- ganisation of the Group’s internal reporting. The fol- rary differences/tax losses, a significant amount of which lowing changes have occurred in regard to the operating can be recovered over a very long period of time. This segments for which separate information was reported at is compatible with a scenario where the emergence from December 31, 2009: crisis and economic recovery are delayed with respect to —— the Real Estate and Broadband Access operating the time horizon implicit in the plans mentioned above. segments were spun off and sold, respectively, during 2010. They are classified as discontinued opera- Provisions for liabilities and charges tions at December 31, 2010. The spin-off and sale transactions are described in detail in the Directors’ Provisions are set aside against contingent legal and fis- Report on Operations and in the Explanatory Notes; cal liabilities, representing the risk of losing lawsuits. —— in accordance with the 2011-2013 Business Plan, The amount of provisions recognised in relation to separate information is no longer reported for the these liabilities represents the best estimate at the re- Eco Technology segment. porting date made by management for lawsuits and tax claims regarding a vast range of issues which are subject Segment results for 2010 are as follows: to the jurisdiction of various countries. Such an esti-

(in thousands of euro) Tyre Other activities Eliminations and Total 2010 adjustments Sales to Third parties 4,771,141 77,277 - 4,848,418 Sales to Group companies 860 17,529 (18,389) - Total net sales 4,772,001 94,806 (18,389) 4,848,418 Gross operating profit 661,135 (32,144) - 628,991 Depreciation and amortisation (208,039) (13,189) - (221,228) Operating income 453,096 (45,333) - 407,763 Net income (loss) from equity investments 277 244,506 (221,326) 23,457 Financial income/(expenses) (66,392) 599 - (65,793) Net income (loss) before income taxes 386,981 199,772 (221,326) 365,427 Income taxes (134,429) (2,929) - (137,358) Net income (loss) from continuing operations 252,552 196,843 (221,326) 228,069

Net income (loss) from discontinued operations (223,840)

Net income (loss) 4,229 118 Annual Financial Report at December 31, 2010 Volume 1

Segment results for 2009 are as follows:

(in thousands of euro) Tyre Other activities Eliminations and Total 2009 adjustments Sales to Third parties 3,992,869 74,592 - 4,067,461 Sales to Group companies 3 20,729 (20,732) - Total net sales 3,992,872 95,321 (20,732) 4,067,461 Gross operating profit 500,977 (48,036) (400) 452,541 Depreciation and amortisation (192,444) (10,418) - (202,862) Operating income 308,533 (58,454) (400) 249,679 Net income (loss) from equity investments 4,239 42,902 (58,741) (11,600) Financial income/(expenses) (76,177) 6,064 - (70,113) Net income (loss) before income taxes 236,595 (9,488) (59,141) 167,966 Income taxes (89,960) (390) - (90,350) Net income (loss) from continuing operations 146,635 (9,878) (59,141) 77,616

Net income (loss) from discontinued operations (100,202)

Net income (loss) (22,586)

The assets, liabilities and capital expenditure broken down by segment at December 31, 2010 are as follows:

(in thousands of euro) Tyre Other activities Eliminations and Total 12/31/2010 adjustments Segment assets 4,127,756 274,010 (42,596) 4,359,170 Investments in associates and joint ventures 13,590 133,493 5,843 152,926 Total allocated assets 4,141,346 407,503 (36,753) 4,512,096 Unallocated assets 1,106,704 Total assets 5,618,800 Segment liabilities 1,954,560 271,044 (22,696) 2,202,908 Unallocated liabilities 1,387,909 Total liabilities 3,590,817

Purchase of property, plant and equipment 402,091 30,978 - 433,069 Purchase of intangible assets 2,948 1,880 - 4,828

The assets, liabilities and capital expenditure broken down by segment at December 31, 2009 are as follows:

(in thousands of euro) Tyre Other Discontinued Eliminations Total activities operations and 12/31/2009 adjustments Segment assets 3,599,538 294,324 547,767 (60,011) 4,381,618 Investments in associates and joint ventures 1,200 129,191 458,256 4,590 593,237 Total allocated assets 3,600,738 423,515 1,006,023 (55,421) 4,974,855 Unallocated assets 1,752,406 Total assets 6,727,261 Segment liabilities 1,620,040 268,274 341,279 (34,350) 2,195,243 Unallocated liabilities 2,037,347 Total liabilities 4,232,590

Purchase of property, plant and equipment 217,059 5,285 2,887 - 225,231 Purchase of intangible assets 367 3,981 15,367 - 19,715 Consolidated financial statements 119

Segment assets consist mainly of property, plant and payables and both current and deferred tax liabilities are equipment and intangible assets, leased assets, invento- excluded. ries, trade receivables and other receivables. Financial receivables, cash and cash equivalents, other financial Capital expenditure mainly relates to the purchase of assets, securities held for trading and both current and property plant and equipment. deferred tax assets are excluded. Net sales by geographical area are shown below. They Segment liabilities mainly comprise trade payables and are allocated on the basis of the country in which the cus- other payables, advances from customers and provisions tomer is resident. for contingent liabilities and employee benefits. Financial (in thousands of euro) 2010 2009 Europe: —— Italy 485,450 10.01% 443,103 10.89% —— Rest of Europe 1,503,531 31.00% 1,326,326 32.60% NAFTA 477,394 9.85% 361,454 8.89% Central and South America 1,632,044 33.66% 1,296,285 31.87% Asia/Pacific 286,922 5.93% 231,237 5.69% Middle East/Africa 463,077 9.55% 409,056 10.06% 4,848,418 100.00% 4,067,461 100.00%

The geographical areas of 2009 have been reclassified to reflect the new definitions given in the 2011-2013 Busi- ness Plan and are consistent with the categories used for internal management reports. The geographical areas at December 31, 2009 were as follows: —— Italy —— Rest of Europe —— North America —— Central and South America —— Oceania, Africa and Asia.

Non-current assets by geographical area are shown below. They are allocated on the basis of the country where these assets are located.

(in thousands of euro) 12/31/2010 12/31/2009 Europe: —— Italy 395,275 13.99% 385,345 13.88% —— Rest of Europe 535,884 18.96% 516,268 18.61% NAFTA 58,191 2.06% 45,422 1.64% Central and South America 589,762 20.87% 484,285 17.45% Asia/Pacific 216,597 7.66% 170,703 6.15% Middle East/Africa 195,697 6.93% 154,988 5.59% Non current assets not allocated 834,461 29.53% 1,017,854 36.68% 2,825,867 100.00% 2,774,865 100.00%

The allocated non-current assets shown in the table above consist of property, plant and equipment and intangible assets, excluding goodwill. The unallocated non-current assets pertain to goodwill (see note 9). 120 Annual Financial Report at December 31, 2010 Volume 1

8. PROPERTY, PLANT AND EQUIPMENT

At December 31, 2010 the breakdown and changes are as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Gross Amount Accumulated Net Amount Gross Amount Accumulated Net Amount Depreciation Depreciation Land 86,826 - 86,826 87,458 - 87,458 Buildings 822,873 (369,371) 453,502 735,295 (337,542) 397,753 Plant and Machinery 3,142,269 (1,911,773) 1,230,496 2,791,177 (1,731,094) 1,060,083 Industrial and commercial equipment 645,340 (510,293) 135,047 598,038 (471,172) 126,866 Other assets 216,489 (145,254) 71,235 230,698 (175,467) 55,231 4,913,797 (2,936,691) 1,977,106 4,442,666 (2,715,275) 1,727,391

GROSS AMOUNT (in thousands of euro)

- ued ued Other effect scope cation Hyper- inflation Increase Decrease Discontin Change in Reclassifi- operations 12/31/2010 12/31/2009 Translation Translation differences Land 87,458 (1,530) - - 2,851 2,558 (4,869) 279 79 86,826 Buildings 735,295 (15,286) (23,579) 6,454 29,283 85,298 1,430 3,582 396 822,873 Plant and Machinery 2,791,177 (3,081) 2,196 6,903 140,070 266,813 (44,253) (10,686) (6,870) 3,142,269 Industrial and commercial equipment 598,038 (4,745) (4,767) 2,073 30,802 37,596 (24,478) 15,311 (4,490) 645,340 Other assets 230,698 (26,223) 1,374 256 7,154 40,804 (25,548) (8,486) (3,540) 216,489 4,442,666 (50,865) (24,776) 15,686 210,160 433,069 (97,718) - (14,425) 4,913,797

ACCUMULATED DEPRECIATION (in thousands of euro)

ued tion Other effect scope cation Hyper- inflation Decrease Deprecia- Change in Discontin - Reclassifi- operations 12/31/2009 12/31/2010 Translation Translation differences Buildings (337,542) 7,751 982 (5,513) (14,299) (248) 1,577 (22,785) 706 (369,371) Plant and Machinery (1,731,094) 2,193 (873) (5,003) (76,998) (1,246) 36,430 (140,018) 4,836 (1,911,773) Industrial and commercial equipment (471,172) 2,952 2,881 (1,714) (24,751) 4,752 16,880 (43,860) 3,739 (510,293) Other assets (175,467) 17,747 (886) (224) (5,760) (3,258) 24,878 (10,200) 7,916 (145,254) (2,715,275) 30,643 2,104 (12,454) (121,808) - 79,765 (216,863) 17,197 (2,936,691)

Net amount (in thousands of euro)

ued tion Other effect scope cation Hyper- inflation Increase Decrease Deprecia- Change in Discontin - Reclassifi- operations 12/31/2009 12/31/2010 Translation Translation differences Land 87,458 (1,530) - - 2,851 2,558 (4,869) 279 - 79 86,826 Buildings 397,753 (7,535) (22,597) 941 14,984 85,298 3,007 3,334 (22,785) 1,102 453,502 Plant and machinery 1,060,083 (888) 1,323 1,900 63,072 266,813 (7,823) (11,932) (140,018) (2,034) 1,230,496 Industrial and commercial equipment 126,866 (1,793) (1,886) 359 6,051 37,596 (7,598) 20,063 (43,860) (751) 135,047 Other assets 55,231 (8,476) 488 32 1,394 40,804 (670) (11,744) (10,200) 4,376 71,235 1,727,391 (20,222) (22,672) 3,232 88,352 433,069 (17,953) - (216,863) 2,772 1,977,106 Consolidated financial statements 121

At December 31, 2009, the changes were as follows:

GROSS AMOUNT (in thousands of euro) Other effect scope cation Hyper- inflation Increase Decrease Change in Reclassifi- 12/31/2008 12/31/2009 Translation Translation differences Land 83,456 - - 2,967 837 (1,570) 33 1,735 87,458 Buildings 625,712 19,080 16,353 19,775 50,901 (15,100) 9,484 9,090 735,295 Plant and Machinery 2,549,392 15,863 15,545 147,970 125,000 (32,232) (14,102) (16,259) 2,791,177 Industrial and commercial equipment 525,374 - 3,970 33,756 25,416 (12,855) 11,886 10,491 598,038 Other Assets 226,136 - 661 4,328 23,077 (16,941) (7,301) 738 230,698 4,010,070 34,943 36,529 208,796 225,231 (78,698) - 5,795 4,442,666

ACCUMULATED DEPRECIATION (in thousands of euro) tion Other effect scope cation Hyper- inflation Decrease Deprecia- Change in Reclassifi- 12/31/2008 12/31/2009 Translation Translation differences Buildings (296,474) - (13,760) (10,779) (10) 5,358 (21,248) (629) (337,542) Plant and Machinery (1,537,876) - (10,809) (83,741) 172 26,230 (125,013) (57) (1,731,094) Industrial and Commercial Equipment (410,590) - (3,214) (27,907) 3,329 10,450 (43,273) 33 (471,172) Other Assets (167,084) - (466) (5,860) (3,491) 15,545 (12,153) (1,958) (175,467) (2,412,024) - (28,249) (128,287) - 57,583 (201,687) (2,611) (2,715,275)

NET AMOUNT (in thousands of euro) tion Other effect scope cation Hyper- inflation Increase Decrease Deprecia- Change in Reclassifi- 12/31/2008 12/31/2009 Translation Translation differences Land 83,456 - - 2,967 837 (1,570) 33 - 1,735 87,458 Buildings 329,238 19,080 2,593 8,996 50,901 (9,742) 9,474 (21,248) 8,461 397,753 Plant and Machinery 1,011,516 15,863 4,736 64,229 125,000 (6,002) (13,930) (125,013) (16,316) 1,060,083 Industrial and Commercial Equipment 114,784 - 756 5,849 25,416 (2,405) 15,215 (43,273) 10,524 126,866 Other Assets 59,052 - 195 (1,532) 23,077 (1,396) (10,792) (12,153) (1,220) 55,231 1,598,046 34,943 8,280 80,509 225,231 (21,115) - (201,687) 3,184 1,727,391 122 Annual Financial Report at December 31, 2010 Volume 1

The increases in 2010 mainly involved the Tyre seg- —— the subsidiary Pirelli Tyres Alexandria Co. posted the ment and were mainly dedicated to increasing manu- value of plant and machinery totalling euro 8,206 facturing capacity in Brazil, China and Romania, as thousand (euro 9,039 thousand at December 31, well as completion of the new production site at Set- 2009) as collateral for loans granted by the National timo Torinese in Italy, which will be opened in 2011. Bank of Egypt; —— the subsidiary Pirelli Pneus Ltda pledged its machin- The ratio of increases of property, plant and equip- ery and land as collateral for a total of euro 62,403 ment to depreciation in 2010 was 2. thousand (euro 52,788 thousand at December 31, 2009) against bank loans granted by BNDES (Ban- Construction in progress at December 31, 2010, co Nacional de Desenvolvimento) and litigation with included the individual categories of property, plant the national social security institution INSS (Insti- and equipment, totalled euro 220,361 thousand (euro tuto Nacional de Seguridade Social). 142,629 thousand at December 31, 2009). No borrowing costs were capitalised on property, plant and equipment. The impairment losses for 2010, included in the “gross amount - decrease” column in the above table, totalled 8.1. FINANCE LEASES euro 7,369 thousand (euro 13,970 thousand at Decem- ber 31, 2009). They refer mainly to plant and machinery The value of land, buildings, plant, machinery and other no longer used at the site of Pirelli Tyre S.p.A. at Settimo assets for which the Group has entered into a financial Torinese (former car plant). leasing agreement is included in the respective categories They are accounted for in the income statement under of property, plant, and equipment. the item “Amortisation, depreciation and impairment” (note 32). The breakdown is shown as follows: In regard to restrictions on the ownership of assets, note that:

(in thousands of euro) 12/31/2010 12/31/2009 Cost Accumulated Net Amount Capitalised cost Accumulated Net Amount depreciation depreciation Leased land 10,184 - 10,184 10,470 - 10,470 Leased buildings 46,158 (8,338) 37,820 66,320 (8,082) 58,238 Other leased assets 454 (115) 339 17,311 (9,606) 7,705 Leased plant and machinary 95 (95) - 92 (92) - 56,891 (8,548) 48,343 94,193 (17,780) 76,413

The value of leased land and leased buildings mainly re- Utility S.p.A. and Solar Prometheus S.r.l., to the new fers to the lease agreement made by Pirelli & C. S.p.A. company GP Energia S.p.A., of which GWM Renewable with a pool of banks (SG Leasing S.p.A. and UniCredit Energy (a company belonging to GWM Group and spe- Leasing S.p.A.) for the building that hosts the structures cialised in investments in renewable energy) owns 60% and activities of the Tyre Segment in Italy. The agree- and Solar Utility S.p.A. the remaining 40% (see note 9). ment, in place since May 2000, has a term of 13 years and includes a purchase option on expiry. The lease in- The decrease in other leased assets from the previous stalments are indexed to 3-month Euribor. The net car- year stems from purchase by the subsidiary Perseo S.r.l. rying amount of the building is euro 36,925 thousand of the airplane previously held under a finance lease. The (euro 38,585 thousand at December 31, 2009) and the airplane was subsequently sold to third parties. carrying amount for the land is euro 10,184 thousand (unchanged from December 31, 2009). The payables for finance leases are included in financial payables (note 24). The change in finance lease payables The decrease in leased buildings from the previous year from the previous year stems from the change in finance is principally related to the grant of productive assets in lease agreements in effect at December 31, 2010 as com- the photovoltaic sector, owned by the subsidiaries Solar pared with the previous year. Consolidated financial statements 123

The minimum payments due (i.e. the payments required from the lessee during the remaining term of the lease) can be broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 up to 1 year 4,537 9,744 from 1 to 5 years 16,835 33,659 more than 5 years 370 18,429 Total 21,742 61,832 Future financial expenses (2,276) (13,904) Amount of leasing payables (note 24) 19,466 47,928

The table below shows the amount of financial lease payables broken down by maturity:

(in thousands of euro) 12/31/2010 12/31/2009 up to 1 year 3,234 7,005 from 1 to 5 years 15,963 27,858 more than 5 years 269 13,065 Total (note 24) 19,466 47,928

9. INTANGIBLE ASSETS

The breakdown and changes for intangible assets are shown as follows:

(in thousands of euro) 12/31/2009 Translation Discontin- Increase Decrease Amortisa- Other 12/31/2010 differences ued operation tions Patents and intellectual property rights 292 - - - - (131) - 161 Concessions/licenses/ trademarks 19,601 638 (12,099) 167 - (926) 253 7,634 Goodwill 1,017,855 71 (181,038) - (2,372) - (55) 834,461 Application software 7,779 26 (3,731) 2,039 (2) (2,654) 93 3,550 Other intangible assets 1,947 24 (55) 2,622 (458) (655) (470) 2,955 1,047,474 759 (196,923) 4,828 (2,832) (4,366) (179) 848,761

(in thousands of euro) 12/31/2008 Translation Change in Increase Decrease Amortisa- Other 12/31/2009 differences scope tion Patents and intellectual property rights 424 - - - - (132) - 292 Concessions/licenses/ trademarks 25,070 (203) - 253 (3,854) (1,614) (51) 19,601 Goodwill 1,007,685 (10) - 16,414 (6,262) - 28 1,017,855 Application software 12,129 7 (243) 2,242 (10) (6,458) 112 7,779 Other intangible assets 800 13 90 806 - (1,222) 1,460 1,947 1,046,108 (193) (153) 19,715 (10,126) (9,426) 1,549 1,047,474 124 Annual Financial Report at December 31, 2010 Volume 1

In regard to “Goodwill” the “decreases” in 2010 result- additional plant. The “discontinued operations” col- ed from the grant of productive assets in the photovoltaic umn refers entirely to the Real Estate operating segment, sector, owned by the subsidiary Solar Utility S.p.A., to which was spun off in 2010. the new company GP Energia S.p.A., of which GWM Renewable Energy (a company belonging to GWM The allocation of goodwill by operating segment, the cash Group and specialised in investments in renewable en- generating units (or Groups of cash generating units) to ergy) owns 60% and Solar Utility S.p.A. the remaining which it was allocated for the impairment testing and the 40%. The shareholding of Solar Utility S.p.A., which was method used to assess the recoverable amount are shown reduced in September 2010 to 31% due to the disposal in the following table: of shares, rose to 35% in early 2011 following the grant of

(in thousands of euro) Operating segment Cash generating unit/ 12/31/2010 12/31/2009 Recoverable amount Groups of cash generating unit Tyre Consumer 517,174 517,165 Value in use Tyre Industrial 312,427 312,419 Value in use Other Eco Technology 4,860 4,860 Value in use Other Environment 2,372 Fair value Real Estate Real Estate 32,910 Value in use Real Estate Agency 5,814 Value in use Real Estate Credit Servicing 4,226 Value in use Real Estate Property 13,356 Value in use Real Estate Poland 3,257 Value in use Real Estate Fund management 26,139 Value in use Real Estate Germany 95,184 Value in use Real Estate Non-performing Loans 152 Value in use 834,461 1,017,854

Goodwill was tested for impairment at December 31, generating units and three years for the Eco Technology 2010, relying on the assistance of an external appraisal. cash generating unit. It was decided to use a time hori- This involved estimating the recoverable amount of the zon of two years for the Consumer and Industrial cash cash generating units and comparing it with the net car- generating units due to the divergence in the 2013 finan- rying amount of the relevant assets, including goodwill. cial year between the value of certain variables forecast Value in use corresponds to the discounted value of the by management in the Business Plan and consensus data future cash flows that are expected to be associated with accepted by leading financial analysts. the cash generating units, using a rate that reflects the specific risks of the single cash generating units at the The calculation also factored in the hypothetical flow de- measurement date. riving from the disposal of cash generating units at the In applying this method management uses many assump- end of the explicit period (assumed to be the discounted tions, including estimates of future sales increases, op- value of the perpetual return of the flow generated in the erating cash flows, the rate of growth of terminal values last year of the projection). This flow was extrapolated and the weighted average cost of capital (discount rate). without applying a growth factor for the Consumer and More specifically, the cash flows approved by manage- Industrial cash generating units (2% in 2009), while a ment used to determine the value in use cover a time ho- growth factor of 2% was applied for the Eco Technology rizon of two years for the Consumer and Industrial cash cash generating unit (2% in 2009). Consolidated financial statements 125

The discount rates, defined as the average cost of capital net of taxes, applied to prospective cash flows are shown in the following table:

Operating segment Cash generating unit/Groups of Discount rate cash generating units 2010 2009 Tyre Consumer 8.06% 9.16% Tyre Industrial 8.06% 9.16% Other Eco Technology 9.80% 9.20% Real Estate Real Estate 6.5% - 8% Real Estate Agency 6.50% Real Estate Credit Servicing 6.50% Real Estate Property 6.50% Real Estate Poland 6.5% - 8% Real Estate Fund management 6.50% Real Estate Germany 6.50% Real Estate Non performing Loans 6.50%

The tests did not reveal any impairment loss. 10. INVESTMENTS A sensitivity analysis of the results was also carried out. IN ASSOCIATES In all cases the values in use remain higher than the carrying amounts even assuming a change in key parameters AND JOINT VENTURES such as: —— a change in discount rates by 50 basis points (hun- Equity investments in associates and joint ventures dredths of a percentage point); amounted to euro 152,927 thousand compared with —— a change in the growth rate by 50 basis points. euro 593,237 thousand at December 31, 2009.

The following changes occurred during the year: ( in thousands of euro) 12/31/2010 12/31/2009 Opening balance 593,237 515,300 Discontinued operations (458,055) - Acquisition/change in share capital and reserves 16,904 40,247 Distribution of dividends (2,288) (10,105) Impairment (529) (16,000) Reversals of impairment 3,956 - Disposals and liquidations - (166) Share of net income (loss) 256 (61,161) Share of other components recognised in Equity (561) (1,629) Decrease in financial receivables - 114,629 Reclassifications and other 7 57,513 Changes in provisions for liabilities and charges - (45,391) Closing balance 152,927 593,237 126 Annual Financial Report at December 31, 2010 Volume 1

The following table shows in detail the changes in equity investments in associates:

(in thousands of euro) tions (loss) Other Share of Share changes in Equity Discontin - 12/31/2009 12/31/2010 ued opera - net income recognised recognised impairment Impairment Distribution of dividends Reversals of share capital share Components and reserves and reserves Acquisitions/ Acquisitions/ Associates of Pirelli RE 150,693 (150,693) ------Eurostazioni S,p,A, 57,757 - - - (1,523) - - 2,564 - 58,798 CyOptics Inc, 13,579 - - - - - 3,956 - - 17,535 RCS MediaGroup S,p,A, 61,901 - - (561) - (514) - (2,975) - 57,851 Sino Italian Wire Tech, Co, Ltd - - 12,984 - - - (405) - 12,579 GP Energia S,r,l, - - 3,920 ------3,920 Other companies 1,945 - - - (765) (15) - 1,072 7 2,244 Associates 285,875 (150,693) 16,904 (561) (2,288) (529) 3,956 256 7 152,927

The equity investment in the company RCS Media- The equity investments in joint ventures, totalling euro Group S.p.A (5.3% of the voting shares) is owned by 307,365 thousand at December 31, 2009, referred en- Pirelli & C. S.p.A., one of the major shareholders. It is tirely to the Real Estate business, which was spun off in represented on the Board of Directors and is a party 2010. At December 31, 2010 the Group did not have any to the shareholders’ agreement, which aims to ensure equity investments in joint ventures. the stability of the shareholding structure and coherent strategies in the management of the RCS Group The “Acquisitions” mainly consist of the purchase (the parties to the agreement hold shares representing by Pirelli Tyre S.p.A. of 49% of Sino Italian Wire Tech. 63.5% of the share capital). Co. Ltd, based in China and operating in the steel The last published accounts (the interim financial state- cord business. ments at September 30, 2010) were used to consolidate this equity investment according to the equity method. The “Reversals of impairment” refers to the equity in- The fair value attributable to the Equity investment in vestment in CyOptics Inc. and stems from the increase the associate RCS MediaGroup S.p.A., which is listed in the recoverable amount of the equity investment with on the Milan Stock Exchange, calculated using the refer- respect to its carrying value. The amount of the reversal, ence price at December 31, 2010 (euro 1.04 per share), euro 3,956 thousand, was determined by considering the was euro 40.7 million (euro 49.6 million in 2009, using consideration resulting from disposal of the investment at the reference price of euro 1.268 per share at December the beginning of 2011. 31, 2009). The decrease in the share price of this stock from De- In regard to the column “Share of net income (loss),” cember 31, 2009 is an indicator of impairment. Conse- see the comments made below at note 34.1 “share of net quently, the equity investment was tested for impairment income (loss) of associates and joint ventures.” and adjusted to its value in use (euro 1.48 per share). Its value in use was determined with the assistance of an The highlights for the principal associates at December external appraisal, resulting in an impairment loss of euro 31, 2010 are illustrated as follows: 514 thousand that was charged to income statement. (in thousands of euro) 12/31/2010 Non current assets 2,480,481 Current assets 1,089,953 Non current liabilities 1,187,200 Current liabilities 1,153,154

Revenues from sales and services 1,644,700 Production costs (1,642,062) Net income (loss) 733 Consolidated financial statements 127

11. OTHER FINANCIAL ASSETS

These amount to euro 185,267 thousand, compared with euro 228,106 thousand at December 31, 2009. They are broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Available-for-sale financial assets 185,267 221,351 Financial assets carried at amortised cost - 6,755 185,267 228,106

The following changes took place during the year in available-for-sale financial assets:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 221,351 476,300 Discontinued operations (10,552) - Increases 23,516 3,031 Decreases (1,478) (241,984) Impairment (5,881) (20,102) (Gains)/losses transferred to income statement for disposal or impairment losses, previously recognised in Equity (8,656) (792) Adjustment to fair value (33,342) 34,739 Reclassification 388 (41,646) Reversal of reserve for reclassification of equity investments from other financial assets to associates - 12,281 Other (79) (476) Closing balance 185,267 221,351 128 Annual Financial Report at December 31, 2010 Volume 1

At December 31, 2010 available-for-sale financial assets included:

(in thousands of euro) 12/31/2010 12/31/2009 Listed securities Mediobanca S,p,A, 105,330 131,011 Oclaro (formerly Avanex Corporation) - 10,440 Prelios S,p,A, (formerly Pirelli & C, Real Estate S,p,A,) 251 - Advanced Digital Broadcast Holdings SA 9,805 - Other companies 386 1,975 115,772 143,426 Unlisted securities Alitalia S,p,A, 12,805 17,171 Fin, Priv, S,r,l, (Mediobanca shares) 14,399 17,945 Gruppo Banca Leonardo S,p,A, 5,155 8,337 Istituto Europeo di Oncologia S,r,l, 7,177 6,677 FC Internazionale Milano S,p,A, 6,017 6,008 Tlcom I LP 1,482 2,114 Equinox Two SCA 3,566 3,536 Other companies Pirelli RE Group - 2,781 Other companies 5,644 5,581 56,245 70,150 Real Estate Investment funds Fondo Anastasia 13,250 - Tecla Fondo Uffici - 5,461 Armilla - 1,826 Fondo Abitare Sociale 1 - 488 13,250 7,775 185,267 221,351

The increases relate mainly to the Anastasia Real Es- value at the assignment date. This impairment loss is in- tate Investment Fund, in which 29 units were sub- cluded in the income statement item “net income (loss) scribed (euro 7,250 thousand), while another 24 units from discontinued operations.” were acquired from Tiglio I S.r.l. (euro 6,000 thousand); 400,000 shares of Advanced Digital Broadcast Holdings The (gains) losses transferred to income statement, S.A. (7.2% of the share capital, equal to euro 8,479 thou- previously recognised in Equity, mainly refer to sale of sand at November 29, 2010, the closing date of the trans- the equity investment in Oclaro Inc. (gains of euro 9,017 action) obtained as part of the consideration received for thousand transferred to the income statement). the sale of Pirelli Broadband Solutions S.p.A. The adjustment to fair value, totalling a negative euro The decreases mainly include the sale of the entire equity 33,342 thousand, mainly refer to the equity investments investment in Oclaro Inc. (formerly Avanex Corporation). in Mediobanca S.p.A. (negative euro 25,681 thousand), in Alitalia S.p.A. (negative euro 4,367 thousand) and Fin. The impairments refer principally to the equity in- Priv. S.r.l. (negative euro 3,547 thousand). vestment in the Banca Leonardo S.p.A. Group for euro The fair value of listed financial instruments corresponds 3,042 thousand and to the equity investment in Prelios to their stock market price at December 31, 2010. S.p.A. for euro 138 thousand. The latter refers to 567,411 The fair value of unlisted financial instruments and real shares in Pirelli RE (now Prelios) that were not assigned estate investment funds was determined by making esti- to shareholders and consequently impaired to their fair mates on the basis of the best information available. Consolidated financial statements 129

12. DEFERRED TAX ASSETS AND LIABILITIES

This item is broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 (*) Deferred tax assets 69,642 91,164 Provision for deferred tax liabilities (33,733) (44,000) 35,909 47,164

* including discontinued operations totalling euro 27,225 thousand

Deferred tax assets and liabilities have been recognised on the balance sheet if they satisfied the applicable conditions and considering the offsets made for each legal entity. They are broken down as follows, gross of offsets:

(in thousands of euro) 12/31/2010 12/31/2009 Deferred tax assets 170,799 177,826 —— of which recoverable within 12 months 56,889 59,403 —— of which recoverable after 12 months 113,910 118,423 Provision for deferred tax liabilities (134,890) (130,662) —— of which recoverable within 12 months (4,448) (1,311) —— of which recoverable after 12 months (130,442) (129,351) 35,909 47,164

The tax effect of temporary differences and of tax losses carried forward which make up the item at December 31, 2010 and at December 31, 2009 is shown in the following table:

DEFERRED TAX ASSETS (in thousands of euro) 12/31/2010 12/31/2009 Provisions for future liabilities and charges 30,204 30,281 Provisions for employee benefits 38,236 38,044 Stocks 11,727 13,498 Tax losses carried forward 43,649 43,121 Amortisation and depreciation 865 2,060 Trade receivables and other receivables 5,800 16,216 Trade payables and other payables 31,602 17,607 Intercompany transactions - 3,292 Derivatives 7,565 6,386 Other 1,151 7,321 170,799 177,826

PROVISION FOR DEFERRED TAX LIABILITIES (in thousands of euro) 12/31/2010 12/31/2009 Amortisation and depreciation (123,971) (120,409) Other (10,919) (10,253) (134,890) (130,662) 130 Annual Financial Report at December 31, 2010 Volume 1

At December 31, 2010 unrecognised deferred tax as- cember 31, 2009). These amounts refer to situations sets relating to temporary differences amounted to euro where recovery is not deemed likely at this time. 139,228 thousand (euro 95,522 thousand at December Tax losses broken down by maturities, against which no 31, 2009), and those relating to tax losses amounted to deferred tax assets were recognised, are shown below: euro 319,327 thousand (euro 439,862 thousand at De-

(in thousands of euro) Year of expiry 12/31/2010 12/31/2009 2010 - 136,608 2011 11,992 37,796 2012 496,897 518,144 2013 46,280 100,389 2014 5,740 53,353 2015 6,312 24,859 2016 3,321 33,382 2017 15 15 2018 1,163 1,163 2019 1,239 - 2022 13,400 48,663 2024 343 343 2025 12,690 - with no expiry 522,986 628,364 1,122,378 1,583,079

The tax effect of gains and losses recognised directly in equity was a positive euro 2,810 thousand (a positive euro 13. TRADE RECEIVABLES 14,111 thousand at December 31, 2009), and is shown in the statement of comprehensive income. These changes Trade receivables may be broken down as follows: were mainly due to the tax effects associated with actuarial gains/losses on employee benefits, to the adjustment to fair value of available-for-sale financial assets and of derivatives in cash flow hedges.

(in thousands of euro) 12/31/2010 12/31/2009 Total Non-current Current Total * Non-current Current Associates and joint ventures 3,127 - 3,127 89,803 - 89,803 Customers 736,728 - 736,728 721,061 - 721,061 Receivables for contract work 207 - 207 2,802 - 2,802 740,062 - 740,062 813,666 - 813,666 Provision for bad debts (63,381) - (63,381) (77,874) - (77,874) 676,681 - 676,681 735,792 - 735,792

* including discontinued operations totalling Euro 163,246 thousand

The receivables from associates and joint ventures Receivables past due and not yet due were impaired in in 2009 (euro 89,803 thousand) refer almost exclusively accordance with the Group accounting policies described to the Real Estate segment, spun off in 2010. in the paragraph on the accounting standard adopted.

Gross trade receivables totalled euro 740,062 thousand Impaired receivables include both significant single po- (euro 813,666 thousand at December 31, 2009), and sitions subject to individual impairment and positions of these euro 102,075 thousand were past due (euro sharing similar credit risk characteristics that have been 155,323 thousand at December 31, 2009). grouped together and impaired on a collective basis. Consolidated financial statements 131

The change in the provision for bad debts is shown below: (in thousands of euro) 12/31/2010 12/31/2009 Opening balance 77,874 59,989 Discontinued operations (18,361) - Translation differences 2,101 1,350 Accruals 12,995 26,057 Utilization / releases (11,322) (8,970) Changes in scope of consolidation - (552) Other 94 - Closing balance 63,380 77,874

Accruals to the provision for bad debts are recognised in the For trade receivables, the carrying amount is considered ap- income statement at the item “Other costs” (note 33). proximate to the fair value.

14. OTHER RECEIVABLES

Other receivables may be broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Total Non-current Current Total * Non-current Current Receivables from associates and joint ventures —— financial receivables 5,926 - 5,926 405,010 394,554 10,456 —— other receivables 3,466 - 3,466 8,507 884 7,623 Financial receivables from third parties 230,097 222,757 7,340 93,900 91,879 2,021 Trade & other accrued income and prepaid expenses/others 11,002 338 10,664 24,152 4,952 19,200 Receivables from employees 8,799 2,091 6,708 6,989 2,746 4,243 Receivables from social security and welfare institutions 7,061 - 7,061 4,617 - 4,617 Receivables from tax authorities not related to income taxes 88,653 8,929 79,724 67,086 17,492 49,594 Other receivables 135,681 81,415 54,263 161,738 44,723 117,015 490,685 315,531 175,154 771,999 557,230 214,769 Provision for other bad debts (172) (172) (17,625) - (17,625) 490,513 315,531 174,982 754,374 557,230 197,144

* including discontinued operations totalling euro 483,950 thousand

For current and non-current other receivables, the car- The receivables from tax authorities not related to rying amount is considered approximate to the fair value. income taxes refer mainly to receivables for VAT and The financial receivables from associates and joint similar taxes. ventures at December 31, 2009 (euro 405,010 thousand) Non-current other receivables (euro 81,415 thou- refer almost exclusively to the Real Estate segment. sand) refer mainly to amounts deposited as security in Non-current financial receivables from third parties lawsuits and tax litigation involving the Brazilian unit (euro 222,757 thousand) refer primarily: Pirelli Pneus Ltda (euro 68,800 thousand) and to a re- —— to euro 140,419 thousand for the used portion of the ceivable of euro 7,400 thousand relating to a cash grant short-term variable rate credit line granted to Prelios paid in connection with the execution of an equity part- S.p.A. by Pirelli & C. S.p.A. as part of the spin-off of nership agreement. Real Estate segment assets from the Pirelli Group. This The current other receivables (euro 54,263 thousand) amount is due on July 31, 2012 and might be extend- mainly consist of: able until July 31, 2017. The total amount of the credit —— receivables of euro 8,591 thousand for the disposal line is euro 150,000 thousand; of property, plant and equipment; —— to euro 78,409 thousand deposited to guarantee tax and —— advances of euro 20,014 thousand; legal disputes in relation to the subsidiary Pirelli Pneus —— receivables of euro 4,500 thousand from Ceat Ltd Ltda (Brazil), remunerated at market rates. following disposal of the Ceat brand. 132 Annual Financial Report at December 31, 2010 Volume 1

The change in the provision for current other bad debts is shown below:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 17,625 8,079 Discontinued operations (17,557) - Translation differences 2 9 Accruals 171 6,088 Utilization/releases (69) (143) Changes in scope of consolidation - 3,592 Closing balance 172 17,625

15. TAX RECEIVABLES 16. INVENTORIES

Tax receivables refer to income taxes and total euro Inventories can be broken down as follows: 35,990 thousand (including euro 10,755 thousand in non-current assets), compared with euro 51,042 thousand at December 31, 2009 (including euro 9,578 thousand for non-current assets).

(in thousands of euro) 12/31/2010 12/31/2009 Pirelli Tyre 682,048 559,579 Pirelli RE - 96,637 Others 10,211 22,761 692,259 678,977

(in thousands of euro) 12/31/2010 12/31/2009 Raw and auxiliary materials and consumables 200,793 140,923 Sundry materials 1,787 745 Trading properties held for sale - 55,335 Buildings under construction/renovation - 9,603 Work in progress and semi-finished products 64,628 39,659 Finished products 415,672 390,178 Goods purchased for resale 3,723 9,274 Building plots - 31,698 Advances to suppliers 5,656 1,562 692,259 678,977

Impairment losses on inventories recognised in 2010 17. SECURITIES HELD totalled euro 6,525 thousand (euro 18,914 thousand at FOR TRADING December 31, 2009). The reversal of previous impairment totals euro 10,077 thousand (euro 5,455 thousand at December 31, 2009). Securities held for trading amount to euro 209,770 thou- The reduction from December 31, 2009 of inventories sand (euro 161,024 thousand at December 31, 2009) of trading properties held for sale, buildings under con- and consist of: struction/renovation and building plots stems from the —— unlisted floating-rate bonds for euro 188,209; spin-off of the Real Estate segment in 2010. Inventories —— fixed-rate bonds for euro 16,794 thousand, includ- were not subject to any collateral pledges. ing euro 7,502 thousand in listed bonds; Consolidated financial statements 133

—— equities for euro 4,731 thousand, including euro Pirelli & C. S.p.A. of 487,231,561 ordinary shares of 4,408 thousand in listed stock; Prelios S.p.A. (formerly Pirelli RE owned by Pirelli —— other securities for euro 36 thousand. & C. S.p.A.).

The fair value of listed financial instruments corresponds Elimination of the par value of ordinary and to their stock market price at December 31, 2010. savings shares and reverse stock split

The fair value of unlisted financial instruments was esti- In execution of the resolutions passed by the Extraordi- mated using the best information available. nary Shareholders’ Meeting of Pirelli & C. S.p.A. on July 15, 2010, one ordinary share and eight savings shares The changes in fair value are recognised in the income owned by Pirelli & C. S.p.A. were first annulled on July statement at “financial expenses” (note 36). 26, 2010, for the sole purpose of allowing the overall operation, with a corresponding reduction in Share capital from euro 1,556,692,865.28 to euro 1,556,692,862.67. 18. CASH AND CASH Following this reduction, the following transactions were EQUIVALENTS carried out: —— reverse stock split of the outstanding 5,233,142,002 ordinary shares, without indication of par value, at Cash and cash equivalents are concentrated in the the ratio of 1 new ordinary share, without indication Group’s financial companies, holding and sub-holding of par value, for every 11 ordinary shares, without companies. They are used essentially on the market for indication of par value, currently held; short-term maturity deposits with major banking coun- —— reverse stock split of the 134,764,421 savings shares terparties at interest rates in line with the prevailing mar- outstanding, without indication of par value, at the ket terms. ratio of 1 new bearer savings share, without indication of par value and with full entitlements, for every In the statement of cash flows, the balance of cash and 11 bearer savings shares, without indication of par cash equivalents was indicated net of bank overdrafts, to- value, currently held; and 1 new registered savings talling euro 17,955 thousand at December 31, 2010 and share, without indication of par value and with full euro 21,334 thousand at December 31, 2009. entitlements, for every 11 registered savings shares, without indication of par value, currently held. Following this reverse stock split, the Share capital of Pirel- 19. EQUITY li & C. S.p.A. was euro 1,556,692,862.67, represented by a total of 487,991,493 shares without indication of par 19.1 EQUITY ATTRIBUTABLE TO OWNERS OF value, including 475,740,182 (euro 1,517,611,180.58) THE PARENT ordinary shares and 12,251,311 (euro 39,081,682.09) savings shares. The subscribed and paid-up Share capital at Decem- ber 31, 2010 (including treasury shares) is represented Reduction of Share capital through proportionate by 475,740,182 ordinary shares and 12,251,311 savings assignment of 487,231,561 ordinary shares of shares, without par value and having normal entitlements, Pirelli & C. Real Estate S.p.A. (now Prelios S.p.A.) for a total of euro 1,377,879 thousand. owned by Pirelli & C. S.p.A. to ordinary and As prescribed by IAS 32, the Share capital is presented savings shareholders of Pirelli & C. S.p.A. net of the value of treasury shares. Treasury shares amounts to euro 2,146 thousand (351,590 ordinary shares, repre- The Extraordinary Shareholders’ Meeting of July 15, senting 0.07% of ordinary shares, and 408,342 savings 2010 also resolved to reduce the Share capital through shares, representing 3.33% of savings shares). Share capi- assignment of 487,231,561 ordinary shares of Pirelli tal thus totals euro 1,375,733 thousand. & C. Real Estate S.p.A. (now Prelios S.p.A.) owned by The total of treasury shares represents 0.16% of Share Pirelli & C. S.p.A. to ordinary and savings shareholders capital. of Pirelli & C. S.p.A., on the basis of one share in Prelios S.p.A. for each ordinary and/or savings share in Pirelli & The following events altered the share capital in 2010: C. S.p.A. held by the shareholders of Pirelli & C. S.p.A. —— elimination of the par value of ordinary and savings after the reverse stock split. shares and reverse stock split; The Share capital was reduced by an amount equal to the —— reduction of share capital through proportionate as- fair value of Prelios S.p.A. shares (euro 178,813,982.89), signment to ordinary and savings shareholders of i.e. the shares that were assigned, which was determined 134 Annual Financial Report at December 31, 2010 Volume 1

on the basis of the official market price for Prelios S.p.A. shares recognised at the item “Share capital,” including shares reported on July 14, 2010 (the Stock Exchange treasury shares. A balancing entry for this adjustment was trading day prior to the date of the Extraordinary Share- made in the “Share premium reserve.” holders’ Meeting). Following this operation, the Share capital of Pirelli & The share assignment was executed in compliance with C. S.p.A. was euro 1,377,878,879.78 gross of treasury applicable regulatory provisions upon expiry of the statu- shares, represented by a total of 487,991,493 shares with- tory waiting period on October 25, 2010. out indication of par value, including 475,740,182 (euro In compliance with applicable accounting rules, the 1,343,286,427.00) ordinary shares and 12,251,311 (euro amount payable to shareholders was adjusted (from euro 34,592,452.78) savings shares. 178,813,982.89 to euro 211,312,328.01) on the basis of the official market price of Prelios S.p.A. (euro 0.4337) 19.2 eQUITY ATTRIBUTABLE TO on the same date. The euro 32,498.345.12 difference has NON-CONTROLLING INTERESTS been accounted for in a negative Equity reserve named “Reserve for assignment of Prelios S.p.A. shares.” At the Non-controlling interests in Equity fell from euro same time, a loss of euro 156,268 thousand was recog- 319,648 thousand at December 31, 2009 to euro 37,152 nised in income statement in consequence of the assign- thousand at December 31, 2010. The change stems pri- ment of Prelios S.p.A. shares. This amount corresponds marily from the spin-off of Real Estate activities (now to the difference between the amount payable to share- Prelios S.p.A.) from the Pirelli Group, with a reduction holders, which was determined as illustrated above, and of euro 274,831 thousand. the carrying value of the net assets that were assigned. Moreover, the value of treasury shares was adjusted The principal non-controlling interests in Equity are illus- to the average unit value of outstanding shares (euro trated as follows: 278,460.73) in order to standardise the unit value of

(in thousands of euro) 12/31/2010 12/31/2009 Drahtcord Saar Gmbh & Co. K.G. (Germany) 50.00% 50.00% Pirelli & C. Eco Technology S.p.A. (Italy) 49.00% 49.00% Pirelli & C. Ambiente S.p.A. (Italy) 49.00% 49.00% Euro Driver Car S.L. (Spain) 47.18% 49.10% Driver Polska Sp.ZO.O. (Poland) 38.00% 35.50% Driver Italia S.p.A. (Italy) 27.46% 27.63% Pirelli Tyre Co. Ltd (China) 25.00% 25.00% S.C. Cord Romania S.R.L (Romania) 20.00% 20.00% Alexandria Tire Co. S.A.E. (Egypt) 10.90% 10.90% Pirelli de Venezuela C.A. (Venezuela) 3.78% 3.78% Turk Pirelli Lastikleri A.S. (Turkey) 0.01% 0.01% Pirelli & C. Real Estate S.p.A. (Italy) - 41.93% Consolidated financial statements 135

20. STOCK OPTION PLANS shares of Pirelli & C. S.p.A., were extinguished during the year without the issuance of any shares by the Company The Company did not have any stock option plan in (in particular, all the unexercised options of both these place at December 31, 2010. plans expired on November 5, 2010). The Pirelli to People and Group Senior Executives plans, The following tables illustrate the changes in these plans reserved for executives and employees of Pirelli & C. during 2010, up to November 5, 2010, the expiration S.p.A. and other Group entities, who had been grant- date set by both plans for exercising the options. ed non-transferrable options to subscribe/buy ordinary

Pirelli to People 2010 2009 Number of Average Market price in Number of Average Market price in shares exercise price euro shares exercise price euro in euro1 in euro Options existing at 01/01/10 14,537,334 0,996 0,42 15,697,334 0,996 0,26 Options granted during year up to 11/05/10 ------(Options exercised during year up to 11/05/10) ------(Options expired during year up to 11/05/10 for persons who left the group) 477,334 - - 1,160,000 - - Options expired for all intents and purposes on 11/05/103 14,060,000 - - - - - Options exixting at 12/31/10 - - - 14,537,334 0,996 0,42

GROUP SENIOR EXECUTIVES 2010 2009 Number of Average Market price in Number of Average Market price in shares exercise price euro shares exercise price euro in euro1 in euro Options existing at 01/01/10 4,032,001 0,996 0,42 9,789,185 0,996 0,26 Options granted during year up to 11/05/10 ------(Options exercised during year up to 11/05/10) ------(Options expired during year up to 11/05/10 for persons who left the group) 298,667 - - 5,757,184 2 - - Options expired for all intents and purposes on 11/05/104 3,733,334 - - - - - Options exixting at 12/31/10 - - - 4,032,001 0,996 0,42

1 On July 15, 2010, the extraordinary shareholders’ meeting of Pirelli & C, S,p,A, approved a reverse stock split of ordinary and savings shares, at a ratio of 1 new ordinary or savings share for every 11 shares of the same class owned, In consequence of this reverse stock split, the purchase price of each new share subscribed in exercise of the Options was recalculated in the amount of euro 10,956, The same shareholders’ meeting also approved a reduction in the share capital of Pirelli & C, S,p,A,, to be implemented upon expiry of the legal deadline through assignment to ordinary and savings shareholders of 487,231,561 ordinary shares in Pirelli & C, Real Estate owned by the Company, In consequence of this reduction, the purchase price for each new share subscribed in exercise of the Options was recalculated again - as at October 25, 2010 - in the amount of euro 10,589 (the total number of unexercised shares that expired for all intents and purposes on November 5, 2010 also includes the options that expired in consequence of this latter operation), 2 Unexercised options of the Group Senior Executives Plan granted definitively on May 10, 2002 expired for all intents and purposes on May 31, 2009, 3 The General Manager, Dr Francesco Gori, owned 666,667 unexercised options that expired for all intents and purposes on November 5, 2010, 4 The General Manager, Dr Francesco Gori, owned 426,667 unexercised options that expired for all intents and purposes on November 5, 2010, 136 Annual Financial Report at December 31, 2010 Volume 1

21. TAX PAYABLES 22. PROVISIONS FOR LIABILITIES Tax payables refer to income taxes and total euro 70,106 thousand (including euro 5,547 thousand in non-current AND CHARGES liabilities), compared with euro 53,955 thousand at De- cember 31, 2009 (including euro 10,037 thousand for The changes that occurred during the period are shown non-current liabilities). below: provisions for liabilities and charges – non-current portion (in thousands of euro) Opening balance at 12/31/2009 167,793 Discontinued operations (26,949) Translation differences 12,461 Increases 12,255 Utilization / releases (8,484) Reclassification 9,000 Other (344) Closing balance at 12/31/2010 165,732

Provisions for liabilities and charges – current portion (in thousands of euro) Opening balance at 12/31/2009 130,783 Discontinued operations (35,533) Translation differences 2,714 Increases 35,514 Utilization / releases (6,315) Reclassification (9,000) Other (2,179) Closing balance at 12/31/2010 115,984

At December 31, 2010 provisions for liabilities and Increases in the current portion concern mainly the charges – non-current portion refer mainly to provi- Italian based units for disputes on occupational diseases sions set aside for legal and tax disputes concerning the and site clean-up work related to disused tracts of land subsidiary Pirelli Pneus Ltda in Brazil (euro 115,302 thou- connected with the construction of the new Settimo Tori- sand), contingent tax liabilities (euro 26,610 thousand) nese site, and in the United States for product warranties and other contingent liabilities/charges of a commercial and addition to provisions for litigation resulting from the nature and employment disputes (euro 14,232 thousand) businesses sold in the Cable segment. involving the Parent company Pirelli & C. S.p.A. Utilization of the current portion during the period Increases in the non-current portion in the year in- related mainly to closure of the disputes for occupation- volved mainly adjustments related to the needs to cov- al diseases and product warranties of the Italian based er commercial risks, compensation and disputes (euro units, and to the closure of the plant in Spain. 3,357 thousand of the Parent Pirelli & C. S.p.A. and euro 7,514 thousand of the Tyre segment). Certain amounts have been reclassified from provisions for liabilities and charges – current portion – to provi- Provisions for liabilities and charges – current por- sions for risks and charges – non-current portion, due to tion mainly include amounts set aside for disputes, in- a change in the time horizon by which the liability related dustrial risks and product warranties in the Tyre segment to the guarantees offered upon disposal of Pirelli assets in (euro 102,822 thousand). the Cables Energy and Telecommunication Systems segments to Goldman Sachs Capital Partner in July 2005 might arise. Consolidated financial statements 137

23. EMPLOYEE BENEFIT OBLIGATIONS

This item includes:

(in thousands of euro) 12/31/2010 12/31/2009 * Pension funds: —— funded 216,762 222,368 —— unfunded 85,819 92,310 Employees' leaving indemnity (Italian companies) 44,470 51,454 Healthcare plans 19,768 17,899 Other benefits 114,905 67,849 481,724 451,880

* including discontinued operations totalling euro 15,372 thousand

PENSION FUNDS

The following table shows a breakdown of pension funds at December 31, 2010:

(in thousands of euro) 12/31/2010 Germany Total USA UK Other Total funded unfunded countries pension fund pension funds Funded funds Present value of funded liabilities 133,851 868,573 3,351 1,005,775 Fair value of plan assets (81,878) (704,434) (2,701) (789,013) Unfunded funds Present value of unfunded liabilities 85,819 85,819 Net liabilities recognized 85,819 85,819 51,973 164,139 650 216,762 of which: —— Tyre 85,819 85,819 51,973 90,641 650 143,264 —— Other 73,498 73,498

The following table shows a breakdown of pension funds at December 31, 2009:

(in thousands of euro) 12/31/2009 Germany Total USA UK Other Total funded unfunded countries pension fund pension funds Funded funds Present value of funded liabilities 122,199 783,307 2,981 908,487 Fair value of plan assets (76,860) (606,856) (2,403) (686,119) Unfunded funds Present value of unfunded liabilities 92,310 92,310 Net liabilities recognized 92,310 92,310 45,339 176,451 578 222,368 of which: —— Tyre 84,168 84,168 45,339 91,681 578 137,598 —— Real Estate 8,142 8,142 —— Other 84,770 84,770 138 Annual Financial Report at December 31, 2010 Volume 1

The characteristics of the principal pension funds exist- —— UK: these are funded defined-benefit plans based on ing at December 31, 2010 are described as follows: the final salary. They provide a supplementary pen- —— Germany / Tyre segment: this is an unfunded de- sion in addition to the state pension and are admin- fined-benefit plan based on the final salary. It pro- istered in trusts. The plans were closed in 2001. The vides a supplementary pension in addition to the Tyre segment plan was frozen in 2010 for employees state pension. The plan was closed in October 1982, hired before 2001, who were transferred to a defined consequently the members of the plan are employees contribution plan. The plan operated by the subsidi- whose employment began prior to that date; ary Pirelli UK Ltd, which includes the employees in —— USA / Tyre segment: this is a funded defined-benefit the Cables and Systems segment sold in 2005, had plan based on the final salary. It provides a supple- already been frozen at the time of the sale in 2005. mentary pension in addition to the state pension and is administered by a trust. The plan was closed in The changes in the period in the present value of the li- 2001 and frozen in 2003 for employees who were abilities for pension funds (funded and unfunded) are as transferred to a defined-contribution scheme. All follows: members of the plan are retired;

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 1,000,797 817,557 Traslation differences 34,245 38,925 Discontinued operations (8,142) - Movements through Income Statement: —— current service cost 2,128 4,195 —— interest cost 56,820 51,479 —— curtailment/settlement (1,049) - Actuarial (gains)/losses recognized in Equity 60,478 138,070 Employee contributions 317 1,182 Benefits paid (53,442) (53,114) Other (558) 2,503 Closing balance 1,091,594 1,000,797

The changes during the year in the fair value of the pension plan assets are as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance (686,119) (571,437) Translation differences (25,116) (33,372) Movements through Income Statement: —— expected return on plan assets (48,864) (40,416) Actuarial (gains)/losses recognised in Equity (39,665) (56,062) Employer contributions (22,829) (29,171) Employee contributions (13,916) (1,689) Benefits paid 46,937 45,403 Other 559 625 Closing balance (789,013) (686,119) Consolidated financial statements 139

The assumptions used to calculate the expected return on The expected return of each investment class is derived the pension plan assets are based on the expected returns from the market returns available at the reporting date. In of the underlying assets (shares, bonds and deposits). The particular, the expected return on stock is derived from a expected return is derived from the general average of risk-free rate of return with the addition of an adequate the returns expected from the assets for each separately risk premium. identified investment class, with reference to an effective or objective composition of the assets. The following table shows a breakdown of funded pension plan assets:

12/31/2010 12/31/2009 UK USA Other countries UK USA Other countries Shares 63% 70% - 62% 70% - Bonds 27% 25% - 27% 25% - Deposits 2% - - - - - Other 8% 5% 100% 11% 5% 100% 100% 100% 100% 100% 100% 100%

The effective return of pension plan assets was as follows:

(in thousands of euro) USA UK Other countries Total Effective return 2010 - (Gains)/losses (6,961) (81,399) (290) (88,650) Effective return 2009 - (Gains)/losses (13,268) (83,057) (250) (96,575)

The pension fund costs expensed to income statement are as follows:

(in thousands of euro) 2010 2009 Current service cost 2,128 3,812 Interest cost 56,820 51,660 Expected return on plan assets (48,864) (40,416) Curtailment (1,049) - 9,035 15,056

The amounts expensed to income statement are included in the item “Personnel Expense” (note 31). The contributions expected to be paid into the pension funds during 2011 total euro 35,552 thousand. 140 Annual Financial Report at December 31, 2010 Volume 1

EMPLOYEES’ LEAVING INDEMNITIES (TFR) – ITALIAN COMPANIES

Leaving indemnities (Italian companies) changed as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 51,454 56,783 Discontinued operations (5,538) - Movements through Income Statement 2,341 3,333 Curtailment 371 1,987 Actuarial (gains)/losses recognised in Equity 314 2,809 Payments/advances (4,621) (13,453) Other 149 (5) Closing balance 44,470 51,454 of which: —— Tyre 34,767 33,809 —— Real Estate - 4,877 —— Other 9,703 12,768

The changes recognized in the income statement for HEALTHCARE PLANS 2010 relate only to interest expenses accried on leaving indemnities (Italian companies) at December 31, 2009. Healthcare plans are broken down as follows: Following the reform introduced in the 2007 Italian Budget Act, leaving indemnities were transformed into a defined-contribution plan. The amounts expensed to the income statement are included in the item “Personnel Expenses” (note 31).

(in thousands of euro) USA Liabilities recognised at 12/31/2010 19,768 Liabilities recognised at 12/31/2009 17,899

The healthcare plan existing in the United States (Tyre ticipants more than 65 years old. segment) covers white collar staff and factory workers, Contributions are paid by both the employer and the both active and retired. employees. The plan is divided into two components “pre-Medi- The changes in the period in liabilities recognised for care” and “post-Medicare”; the latter is reserved for par- healthcare plans are as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Opening balance 17,899 18,442 Translation differences 1,390 (661) Movements through Income Statement: - current service cost 5 6 - interest cost 1,070 1,090 Actuarial (gains)/losses recognised in Equity 448 (15) Benefits paid (1,044) (963) Closing balance 19,768 17,899 Consolidated financial statements 141

The effect of an increase or decrease of one percentage point in the projected healthcare cost trend rates is as follows:

1% increase 1% decrease 12/31/2010 12/31/2009 12/31/2010 12/31/2009 Effect on current service cost and interest cost 38 40 (36) (39) Effect on liabilities recognised in balance sheet 711 626 (692) (609)

The healthcare plan costs expensed to the income statement are as follows:

(in thousands of euro) 2010 2009 Current service costs 5 6 Interest expense 1,070 1,090 1,075 1,095

The amounts expensed to income are included in the thousand, including the portion relating to companies car- item “Personnel Expense” (note 31). ried at Equity, represented by gains of euro 10 thousand). The cumulative amount of net losses recognized in Eq- ADDITIONAL INFORMATION REGARDING uity at December 31, 2010, euro 405,911 thousand, POST-EMPLOYMENT BENEFITS including euro 405,889 thousand attributable to the owners of the Parent (at December 31, 2009 net losses Net actuarial losses accrued in 2010 and recognised di- totalled euro 383,502 thousand, including euro 383,893 rectly in Equity totalled euro 21,618 thousand (at De- thousand attributable to the owners of the Parent), is cember 31, 2009 net actuarial losses totalled euro 86,633 broken down as follows:

(in thousands of euro) Cumulative 12/31/2010 Italy Germany USA UK Other Total countries Pension funds - (8,924) (85,461) (307,234) (10,404) (412,023) Healthcare plans - - (9,689) - - (9,689) Employees' leaving indemnity 15,801 - - - - 15,801 Total actuarial gains/(losses) recognised in Equity 15,801 (8,924) (95,150) (307,234) (10,404) (405,911)

The breakdown by country at December 31, 2009 was as follows:

(in thousands of euro) Cumulative 12/31/2009 Italy Germany USA UK Other Total countries Pension funds - (5,684) (80,705) (296,227) (8,902) (391,518) Healthcare plans - - (9,242) - - (9,242) Employees' leaving indemnity 17,258 - - - - 17,258 Total actuarial gains/(losses) recognised in Equity 17,258 (5,684) (89,947) (296,227) (8,902) (383,502) 142 Annual Financial Report at December 31, 2010 Volume 1

The principal actuarial assumptions used at December 31, 2010 and for determining the projected cost for 2011 are as follows:

Italy Germany Netherlands UK USA Discount rate 4.75% 4.75% 4.75% 5.40% 5.10% Inflation rate 2.00% 2.00% 2.00% 3.45% - Expected return on plan assets - - - 6.56% 7.25% Expected rate of wage and salary increases 2.00% (*) 2.50% 2.00% 3.30% - Healthcare cost trend rates - initial - - - - 8.00% Healthcare cost trend rates - final - - - - 4.50%

* indicator valid only for companies with less than 50 employees

The principal actuarial assumptions used at December 31, 2009 and for determining the projected cost for 2010 are as follows:

Italy Germany Netherlands UK USA Discount rate 5.00% 5.20% 5.20% 5.70% 5.75% Inflation rate 2.00% 2.00% 2.00% 3.45% - Expected return on plan assets - - - 6.84% 7.39% Expected rate of wage and salary increases 3.00% (*) 2.50% 2.00% 2.70% - 3.45% - Healthcare cost trend rates - initial - - - - 8.00% Healthcare cost trend rates - final - - - - 4.50%

* indicator valid only for companies with less than 50 employees

The discount rates are used to measure the obligation which takes into account, among other factors, inflation and the financial component of the net present cost. in healthcare costs on the basis of the general inflation The Group selected these rates on the basis of the yield trend, incremental medical inflation, technologies, new curve of fixed-income securities (corporate bonds) of drugs, the average age of the population and a different major companies (with AA+ ratings) at the valuation mix of medical services. date of the plans. The expected rates of return on the assets reflect the esti- The healthcare cost trend rate represents the projected mates of the trend in average long-term rates of the pen- increase in expenses for medical assistance. This rate is sion plan assets for the entire duration of the obligation. determined on the basis of the specific experience of the The expected return is defined for each asset class (equi- segment and of various trends, including the specific in- ties, bonds, cash, and real estate) and is net of the pro- flation projections in the healthcare sector. jected administrative costs. The historical trend and the The initial rate used represents a short-term trend based correlation of the returns, estimates of future trends and on recent experience and on prevailing market condi- other significant financial factors are analysed to ensure tions. The final rate used is a long-term assumption that they are reasonable and consistent.

(in thousands of euro) 12/31/2010 12/31/2009 12/31/2008 12/31/2007 12/31/2006 Experience adjustments on plan liabilities - (Gains)/losses 19,295 942 (9,553) 16,097 (7,527) Experience adjustments on plan assets - (Gains)/losses (39,786) (56,158) 224,875 (744) (32,733) Consolidated financial statements 143

The adjustments based on past experience, in relation to The adjustments of the assets represent the difference be- defined benefit plans, are as follows: tween the effective return of the assets and the return ex- The adjustments of liabilities represent the change of the pected at the beginning of the year. actuarial liability not deriving from modifications of the actuarial assumptions. They normally include changes in OTHER BENEFITS the demographic and compensation structure. Changes to the plan rules (past service costs) are excluded from Other benefits are broken down as follows: the past experience.

(in thousands of euro) 12/31/2010 12/31/2009 * Long term bonus plan 57,847 18,681 Jubilee awards 13,249 15,035 Benefits similiar to employees' leaving indemnity - non Italian companies 23,840 18,369 Other long term benefits 19,969 15,764 114,905 67,849

* including discontinued operations totalling euro 2,353 thousand

The long-term bonus plan for management, amounting to euro 57,847 thousand (euro 18,681 thousand at 24. BORROWINGS FROM December 31, 2009) reflects the amount accrued during BANKS AND OTHER the year for that plan, approved by the Board of Directors of Pirelli & C. S.p.A. on April 21, 2009 and reserved for FINANCIAL INSTITUTIONS approximately 80 senior managers. Borrowings from banks and other financial institutions can be broken down as follows: (in thousands of euro) 12/31/2010 12/31/2009 Total Non-current Current Total * Non-current Current Borrowings from banks 1,028,898 798,960 229,938 1,661,280 1,402,524 258,756 Borrowings from other financial institutions 80,039 78,982 1,057 62,134 60,899 1,235 Financial lease payables 19,466 16,232 3,234 47,928 40,923 7,005 Financial accrued expenses and deferred income 9,037 537 8,500 14,168 789 13,379 Other financial payables 4,786 - 4,786 9,600 670 8,930 1,142,226 894,711 247,515 1,795,110 1,505,805 289,305

* including discontinued operations totallling euro 454.078 thousand

Financial payables backed by secured guarantees (pledg- Current payables include the portion of non-current fies and mortgages) totalled euro 16,593 thousand (euro nancial payables, totalling euro 150,000 thousand (euro 23,845 thousand at December 31, 2009). 141,000 thousand at December 31, 2009), that will be For current payables, the carrying amount is considered settled within one year. approximate to their fair value. The fair value of non-current payables is shown below, compared with their carrying amount: (in thousands of euro) 12/31/2010 12/31/2009 Carrying amount Fair value Carrying amount Fair value Non-current financial payables 894,711 901,485 1,505,805 1,503,800 144 Annual Financial Report at December 31, 2010 Volume 1

At December 31, 2010, the breakdown of payables by interest rate and by currency of origin of the debt is as follows:

(in thousands of euro) Fixed rate Variable rate 12/31/2010 EUR 17,307 53,201 70,508 USD - - - BRL (Brazil Real) 93,617 - 93,617 CNY (Chinese Renminbi) 30,681 31,861 62,542 Other currencies 20,848 - 20,848 Current payables 162,453 66% 85,062 34% 247,515

EUR 579,861 120,696 700,557 USD 6,705 - 6,705 BRL (Brazil Real) 8,306 48,038 56,344 CNY (Chinese Renminbi) - 61,050 61,050 RON - 70,055 70,055 Non-current payables 594,872 66% 299,839 34% 894,711

757,325 66% 384,901 34% 1,142,226

The situation at December 31, 2009 was as follows:

(in thousands of euro) Fixed rate Variable rate 12/31/2009 EUR 117,507 68,683 186,190 USD - - - BRL (Brazil Real) 43,541 - 43,541 CNY (Chinese Renminbi) 27,509 21,315 48,824 Other currencies 10,750 - 10,750 Current payables 199,307 69% 89,998 31% 289,305

EUR 999,043 361,788 1,360,831 USD 7,581 - 7,581 BRL (Brazil Real) 39 32,718 32,757 CNY (Chinese Renminbi) - 54,762 54,762 RON - 49,874 49,874 Non-current payables 1,006,663 67% 499,142 33% 1,505,805

1,205,970 67% 589,140 33% 1,795,110

The value of fixed-rate payables indicated above includes The Group’s exposure to fluctuations in interest rates on those established by contract as fixed-rate payables and financial payables, both in terms of the type of rate and those established by contract as variable-rate payables to their resetting date, are summarised below: offset which hedging derivatives have been put in place.

(in thousands of euro) 12/31/2010 12/31/2009 Total Fixed rate Variable rate Total Fixed rate Variable rate Up to 6 months 476,220 96,304 379,916 457,765 114,132 343,633 From 6 to 12 months 68,646 68,646 - 100,714 100,714 - From 1 to 5 years 596,148 591,163 4,985 1,135,116 889,609 245,507 More than 5 years 1,212 1,212 - 101,515 101,515 - 1,142,226 757,325 384,901 1,795,110 1,205,970 589,140 Consolidated financial statements 145

On November 30, 2010 the Group (and specifically under non-current payables due after 2014. Pirelli & C. S.p.A., Pirelli International Limited and This credit facility was fully repaid and cancelled on Feb- Pirelli Tyre S.p.A., acting as guarantor) entered into a ruary 23, 2011. new five-year revolving credit facility for euro 1,200,000 thousand. This new facility was contracted in order to The new loan agreement was signed with 12 major do- replace similar existing credit facilities totalling euro mestic and international banks: Bank of America-Merrill 1,475,000 thousand (of which euro 800,000 thousand Lynch, Barclays, BNP Paribas, Commerzbank, HSBC, granted to Pirelli & C. S.p.A. and euro 675,000 thou- Intesa Sanpaolo, Mediobanca, Mizuho, Société Générale, sand granted to Pirelli Tyre S.p.A. and Pirelli Interna- The Bank of Tokyo-Mitsubishi, The Royal Bank of Scot- tional Limited), which had been previously contracted land and UniCredit, which all had equal shares. Banca with due dates falling in 2011 and 2012. IMI and BNP Paribas acted as Global Co-ordinators for the deal. Banca IMI is the Facility Agent for the deal. In particular, the syndicated credit facility (granted to Pirelli Tyre S.p.A. and Pirelli International Limited), At December 31, 2010 the Group had, besides cash and signed on February 2007 for a total of euro 675,000 thou- cash equivalents and securities held for trading of euro sand, was initially reduced to euro 400,000 thousand at 454,495 thousand, unused committed credit facilities of December 31, 2010. Utilisation of this facility for euro euro 1,220,000 thousand (euro 819,000 thousand at De- 380,000 thousand at December 31, 2010, was classified cember 31, 2009), with the following maturities:

(in thousands of euro) 12/31/2010 12/31/2009 2011 20,000 155,000 2012 - 664,000 2015 1,200,000 - 1,220,000 819,000

It should be noted that some of the following credit facili- the negative pledges, the credit facility provides for a ties, all of which are revolving, are subject to financial cov- commitment not to grant secured guarantees, above a enants and negative pledge clauses, as follows: threshold defined as the greater of euro 100,000 thou- Tyre: sand and 3% of Total Assets (as defined in the con- —— syndicated facility (granted to Pirelli Tyre S.p.A. and solidated financial statements of Pirelli & C. S.p.A.), Pirelli International Ltd), in which 12 banks partici- with the exception of secured guarantees on the exist- pate for a total amount of euro 675,000 thousand, ing debt or debt to replace it, to be granted pursuant reduced to euro 400,000 thousand at December 31, to law, relating to “export finance,” “project finance” 2010 and utilised for euro 380,000 thousand (fully and subsidised finance. repaid and cancelled on February 23, 2011), for The other outstanding financial payables do not contain which no covenants are envisaged. There is a nega- financial covenants. tive pledge clause which provides for a commitment Five other loans were outstanding at December 31, 2010, not to grant secured guarantees, above a threshold having been granted by the European Investment Bank defined as the greater of euro 100,000 thousand and (EIB) in favour of Pirelli & C. S.p.A. and Pirelli Tyre S.p.A. 3% of Total Assets (as defined in the consolidated for research and development projects and in favour of financial statements of Pirelli Tyre S.p.A.), with the S.C. Pirelli Tyres Romania S.r.l. for local industrial invest- exception of secured guarantees on the existing debt ments. These loans total euro 400,000 thousand, with uti- or debt to replace it, to be granted pursuant to law, lisation of euro 370,000 thousand, and are classified under relating to “export finance,” “project finance” and non-current payables. subsidised finance; —— syndicated credit line for a total of euro 1,200,000 Please see note 8.1 “Finance leases” in regard to finance thousand, which was not used and for which just one lease payables. The change in finance lease payables from financial covenant applies, i.e. the undertaking to the previous year stems from the change in finance lease maintain a certain ratio between consolidated net in- agreements in effect at December 31, 2010 as compared debtedness and gross operating profit. This parameter with the previous year. was fully satisfied at December 31, 2010.In regard to 146 Annual Financial Report at December 31, 2010 Volume 1

25. TRADE PAYABLES

Trade payables may be broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Total Non-current Current Total * Non-current Current Associates and joint ventures 1,439 - 1,439 20,983 - 20,983 Suppliers 1,053,222 - 1,053,222 959,996 - 959,996 Notes payable 11,700 - 11,700 1,933 - 1,933 Payables on contract work - - - 4,961 - 4,961 1,066,361 - 1,066,361 987,873 - 987,873

* including discontinued operations totalling euro 164,073 thousand

For trade payables, the carrying amount is considered approximate to their fair value.

26. OTHER PAYABLES

Other payables may be broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Total Non-current Current Total * Non-current Current Associates and joint ventures 1,210 - 1,210 12,003 2,608 9,395 Trade and other accrued liabilities and deferred receivables 85,180 6,930 78,250 84,963 4,421 80,542 Tax payables 70,811 17,171 53,640 67,593 10,926 56,667 Payables to employees 127,411 74 127,337 141,105 75 141,030 Payables to social security and welfare institutions 50,252 11,130 39,122 44,723 5,078 39,645 Dividends approved 1,125 - 1,125 1,070 - 1,070 Other payables 109,048 6,359 102,689 173,586 10,900 162,686 445,037 41,664 403,373 525,043 34,008 491,035

* including discontinued operations totalling euro 97,125 thousand

Other current payables (euro 102,689 thousand) include: —— euro 5,240 thousand in advances paid by the Re- —— payables of euro 48,131 for the purchase of property, gion of Piedmont to the Tyre segment for research plant and equipment; projects; —— payables of euro 4,079 thousand to agents, profes- —— payables of euro 5,603 thousand for withholding tax sionals and consultants; owed by the Tyre segment; —— payables of euro 3,035 thousand to Directors and —— earnest money of euro 1,800 thousand paid for the Supervisory Body; sale of land in Settimo Torinese; —— payables of euro 580 thousand to Statutory Audi- —— advances from customers of euro 3,280 thousand. tors; —— euro 1,678 thousand in advances paid by the Euro- For other current and non-current payables, the carrying pean Union to the Tyre segment for research projects; amount is considered approximate to the fair value. Consolidated financial statements 147

27. DERIVATIVE FINANCIAL INSTRUMENTS

This item includes the fair value measurement of derivative instruments outstanding at December 31, 2010. They are broken down as follows:

(in thousands of euro) 12/31/2010 12/31/2009 Assets Liabilities Assets Liabilities Non- Current Non- Current Non- Current Non- Current current current current current No hedge accounting adopted Foreign currency derivatives - commercial transactions 32,539 (37,086) 22,745 (22,810) Foreign currency derivatives - included in net financial position 915 (4,810) 3,822 (29,598) Hedge accounting adopted Foreign currency derivatives - commercial transactions 1,705 Interest rate derivatives (28,018) (23,745) 35,159 (69,914) 26,567 (76,153)

The value of foreign currency derivatives for which —— euro 10,598 thousand for losses recognised in Eq- hedge accounting was not adopted corresponds to the fair uity during the year; value of forward currency purchases/sales outstanding at the —— euro 5,386 thousand for immediate reclassification closing date of the period. These involve hedges of Group in the income statement (due to the interruption of commercial and financial transactions for which hedge ac- hedge accounting) of losses that had previously accu- counting was not adopted. The fair value is determined by mulated in Equity for derivative instruments unwound using the exchange rate at the reporting date. in June 2010 and having a notional value of euro 300 million and original maturity in February 2012 (in this The value of foreign currency derivatives for which regard, also see note 36 “Financial expenses”). hedge accounting was adopted corresponds to the fair value of forward currency purchases for the Tyre segment. By means of this hedge, implemented in Q4 2010, the 28. COMMITMENTS AND Tyre segment aims to limit its exposure to the economic CONTINGENCIES effects resulting from a change in the exchange rate on future purchases planned in Q1 2011 that are denominated in U.S. dollars, mainly for natural rubber. GUARANTEES GRANTED IN FAVOUR OF OTHER A positive euro 1,705 thousand was recognised in Equity COMPANIES for 2010. These totalled euro 123 thousand at December 31, 2010 The value of interest rate derivatives for which hedge and were granted in favour of other companies against loans. accounting was adopted corresponds to the measurement of “plain vanilla” interest rate swaps made to hedge COMMITMENTS TO PURCHASE PROPERTY, against a rise in interest rates on a notional amount of PLANT AND EQUIPMENT euro 1,050 million, with euro 375 million maturing in February 2012 and euro 675 million for forward start The commitments to purchase property, plant and transactions beginning in February 2012 and expiring in equipment relate mainly to the Tyre segment and amount February 2015. The amount recognised in Equity for the to euro 197.8 million (euro 128.6 million at December year was a negative euro 5,212 thousand (compared with 31, 2009), mostly regarding companies in Brazil, China, a negative euro 17,814 thousand for 2009), and is broken Italy, Romania, Germany and Mexico. down as follows: 148 Annual Financial Report at December 31, 2010 Volume 1

COMMITMENTS FOR PURCHASE OF EQUITY In the assessment for the 2002 tax year, served at the end INTERESTS/FUND UNITS of 2007, Olimpia was characterised as a “shell company,” on the basis of perfectly arbitrary reclassification of These refer to call options and consist of commitments items on its financial statements and arbitrary statutory by Pirelli Finance (Luxembourg) S.A. to subscribe units interpretations. The Company’s appeal was not only ac- of the company Equinox Two S.c.a., a private equity cepted by the trial court, but the Ministry of Finance was company specialised in investments in listed and unlisted also ordered to pay all legal costs. The IRPEG (corporate companies with high growth potential, for a maximum income tax) claim amounted to euro 29.3 million, plus countervalue of euro 5,887 thousand. penalties for the same amount. Despite such a clear judgement, the Agenzia delle Entrate GUARANTEES GIVEN ON THE SALE OF OLIMPIA lodged its own appeal, which was heard before the Region- al Tax Court. We are awaiting the judgement on this ap- On the sale of the equity interest in Olimpia S.p.A., the peal, which we expect will uphold the trial court decision. sellers (Pirelli and Sintonia) remained contractually lia- At the end of 2008, a second notice of assessment was ble for all the contingent tax liabilities regarding the years served for the 2003 tax year, in which Olimpia was once up to the date of sale. again characterised as a “shell company.” The current tax litigation can be summarised as follows. The IRPEG (corporate income tax) claim amounted to At the end of 2006, the Italian Internal Revenue Agency euro 28.5 million, plus penalties for the same amount. (“Agenzia delle Entrate”) served Olimpia S.p.A. with an The Company appealed to the Tax Court of first instance assessment notice for 2001, concerning IRAP (regional against this tax assessment, which was, like the other tax on productive activity). ones, absolutely unfounded. The Tax Court ruled in fa- More precisely, for this financial year, on the basis of an vour of the Company. assumption which is entirely groundless both legally and Finally, at the end of 2009, a third notice of assessment economically, the Agenzia delle Entrate had found that was served for the 2004 tax year, in which Olimpia was non-existent financial income had been realised on the yet again characterised as a “shell company.” Bell Bond Loan redeemable with Olivetti shares, with a The IRES (corporate income tax) claim amounts to euro consequent IRAP tax of euro 26.5 million, plus penalties 29.6 million, plus penalties for the same amount. for the same amount. This assessment, just like the ones that preceded it, is The Company appealed against this tax assessment, absolutely unfounded. Therefore, the Company lodged claiming that the ascertained taxable income was mani- an appeal against it too before the Tax Court of first in- festly non-existent. stance, which ruled in favour of the Company just as it At the trial level, the Trial Tax Court accepted the Com- had done before. pany’s appeal, cancelling the entire tax assessment. The Agenzia delle Entrate subsequently appealed this decision. 29. REVENUE FROM SALES The appeal by the Agenzia delle Entrate was also rejected AND SERVICES by the Regional Tax Court. Notwithstanding the double judgements against it, the Agenzia delle Entrate filed an appeal with the Court of Cas- The revenue from sales and services is broken down as sation, against which the Company has filed a cross-appeal. follows:

(in thousands of euro) 2010 2009 Revenue from sales of goods 4,764,372 3,994,153 Revenue from services 84,046 73,308 4,848,418 4,067,461 Consolidated financial statements 149

30. OTHER INCOME referring to the Tyre segment and excess provisions for restructuring carried out in 2008. The item amounts to 154,333 thousand compared with euro 147,144 thousand in 2009, and includes revenues for rents, fees, royalties, compensation, insurance indem- 31. PERSONNEL EXPENSE nities and other minor items. The amount for 2009 included income from non-recur- This is broken down as follows: ring events of euro 5,900 thousand (4% of the total)

(in thousands of euro) 2010 2009 Wages and salaries 790,250 708,087 Social security and welfare contributions 165,518 143,621 Expenses for employees' leaving indemnity and similar costs * 36,491 26,334 Expenses for defined-contribution pension funds 16,543 14,005 Expenses for defined-benefit pension funds 9,035 15,056 Expenses for defined-benefit healthcare plans 1,075 1,095 Expenses for jubilee awards 1,041 1,769 Expenses for defined-contribution healthcare plans 30,715 24,955 Other costs 12,980 14,295 1,063,648 949,217

* includes Italian and foreign companies

The item “wages and salaries” includes euro 39,207 thou- thousand in 2009 (5.5% of the total item). In 2009, these sand relating to the portion accruing in the year for the expenses included euro 33,957 thousand for voluntary long-term bonus plan of the management, approved by the redundancy payments made by the Tyre segment and Board of Directors of Pirelli & C. S.p.A. on April 21, 2009. euro 18,167 thousand by other Group companies. These accruals totalled euro 18,681 thousand in 2009.

In regard to the amounts relating to employees’ leaving 32. AMORTISATION, indemnity (TFR), pension funds and defined benefit DEPRECIATION healthcare plans, see the comment on the item “Employ- ee benefit obligation” (note 23). AND IMPAIRMENT

This item also includes euro 18,192 thousand in volun- The amortisation, depreciation and impairment of prop- tary redundancy expenses, mainly relating to the Tyre erty, plant and equipment and intangible assets are bro- segment and classified as non-recurring events (1.7% ken down as follows: of the total for the item), compared with euro 52,124

(in thousands of euro) 2010 2009 Amortisation 4,366 5,105 Depreciation 216,863 197,755 Impairment of intangible assets - 2,518 Impairment of property, plant and equipment 7,369 13,970 228,598 219,348 150 Annual Financial Report at December 31, 2010 Volume 1

The item includes euro 6,500 thousand (2.8% of the total) for impairment associated with the restructuring plans implemented by the Tyre segment, which are classified as non-recurring events. This compares with euro 8,000 thousand (3.6% of the total) for the previous year.

33. OTHER COSTS

This item is broken down as follows:

(in thousands of euro) 2010 2009 Selling costs 239,957 216,255 Purchases of goods for resale 213,634 249,463 Fluids and power 185,346 162,753 Advertising 143,796 139,086 Professional advice 42,046 34,786 Maintenance 51,080 41,738 Warehouse operating costs 40,984 43,431 Leases and rentals 55,181 43,615 Outsourcing 23,203 23,588 Travel expenses 31,541 25,730 IT expenses 24,885 24,018 Compensation of key managers 8,552 5,871 Other provisions 35,051 65,876 Duty stamps, duties and local taxes 30,941 22,880 Canteen 17,674 13,459 Bad debts 12,991 16,474 Insurance 23,227 20,587 Lease instalments 13,082 13,083 Cleaning expenses 13,482 10,430 Waste disposal 9,241 8,712 Security expenses 7,620 7,504 Telephone expenses 9,279 6,374 Other 210,289 121,459 1,443,082 1,317,172

Selling costs mainly include contractual expenses for the 34. NET INCOME (LOSS) signing of sales contracts, shipments and transport on do- FROM EQUITY INVESTMENTS mestic and foreign markets, commissions to agents and sales staff, customs duties and the operating costs of external warehouses. 34.1 SHARE OF NET INCOME OF ASSOCIATES AND JOINT VENTURES

The Group’s share of net income of associates and joint ventures accounted for using the Equity method was a positive euro 256 thousand, compared with a positive euro 225 thousand in 2009. Consolidated financial statements 151

34.2 GAINS FROM EQUITY INVESTMENTS

This item is broken down as follows:

(in thousands of euro) 2010 2009 Gains on disposal of available-for-sale financial assets 19,539 14,385 Gains on disposal of equity investments in Group companies - 142 Reversal of impairment of equity investments in associates 3,956 - Gains from purchase of non-controlling interests - 3,366 Other gains on equity investments 336 - 23,831 17,893

The gains on disposal of available-for-sale financial rying value. The amount of the reversal, euro 3,956 thou- assets for 2010 refer mainly to disposal of the entire eq- sand, was determined by considering the price received uity investment held in Oclaro Inc. (formerly Avanex), for disposal of the investment at the beginning of 2011. with a gain of euro 18,366 thousand. In 2009 this item included the gain realised on sale of The gains on purchase of non-controlling interests shares held in Alcatel-Lucent Submarine Networks (euro for 2009 was related to the Tyre segment for the gain of 11,195 thousand) and the gain realised on sale of Tel- euro 3,366 thousand realised as the difference between ecom Italia S.p.A. shares held directly and indirectly by the purchase price of the non-controlling interests in Tur- Pirelli & C. S.p.A. (euro 2,251 thousand). key and the corresponding Equity determined in accordance with the Group’s accounting policies. The reversal of impairment of equity investments in associates refers to the equity investment in CyOp- 34.3 LOSSES FROM EQUITY INVESTMENTS tics Inc. and stems from the increase in the recoverable amount of the equity investment with respect to its car- This item is broken down as follows:

(in thousands of euro) 2010 2009 Losses on disposal of available-for-sale financial assets 30 - Impairment of equity investments in associates and joint ventures 585 16,000 Impairment of available-for-sale financial assets 5,850 20,619 6,465 36,619

The item impairment of equity investments in as- 34.4 DIVIDEND INCOME sociates and joint ventures mainly refers to the equity investment in RCS MediaGroup S.p.A., while in the pre- The amount of euro 5,835 thousand for 2010 is com- vious year, the item referred exclusively to the equity in- prised mainly of euro 2,728 thousand from the Gruppo vestment in CyOptics Inc. Banca Leonardo S.p.A., euro 2,678 thousand from Me- diobanca S.p.A. and euro 348 thousand from Fin. Priv. The item impairment of available-for-sale financial S.r.l.. assets refers mainly to the equity investment in the Gruppo In 2009, this item included euro 6,196 thousand from Banca Leonardo S.p.A. (euro 3,042 thousand), in TlCom I Telecom Italia S.p.A., euro 202 thousand from Gruppo Ltd (euro 632 thousand), in Tiglio I S.r.l. (euro 580 thou- Banca Leonardo S.p.A. and euro 252 thousand from Vit- sand) and in Equinox (euro 372 thousand). toria Capital N.V. In 2009 it consisted principally of impairment of the equity investment in Telecom Italia S.p.A. (euro 19,754 thousand). 152 Annual Financial Report at December 31, 2010 Volume 1

35. FINANCIAL INCOME

Financial income is broken down as follows:

(in thousands of euro) 2010 2009 Interest 22,258 25,901 Other financial income 11,506 14,321 Gains on exchange rates 263,770 304,199 Fair value measurement of securities held for trading - 339 297,534 344,760

Gains on exchange rates include the adjustment to the year-end exchange rates of items expressed in currencies other than the functional currency still open at the reporting date and gains made on items realised during the year.

36. FINANCIAL EXPENSES

These are broken down as follows:

(in thousands of euro) 2010 2009 Interest to banks 47,098 48,196 Other financial expenses 36,449 36,897 Losses on exchange rates 263,784 288,609 Fair value measurement of securities held for trading 1,916 - Fair value measurement of currency derivatives 8,376 41,117 Fair value measurement of other derivative instruments 5,704 54 363,327 414,873

Other financial expenses are mainly comprised of the tween the two currencies subject to the individual hedges, a euro 11,702 thousand effect of adopting inflation account- net hedging cost of euro 9,959 thousand, and the exchange ing by Pirelli de Venezuela C.A. (also see note 41). rate component, a net gain of euro 1,584 thousand. Com- paring the latter with the exchange differences on items in Losses on exchange rates include the adjustment to the foreign currencies, a net loss of euro 14 thousand (losses year-end exchange rates of items expressed in currencies on exchange rates of euro 263,784 thousand and gains on other than the functional currency still open at the reporting exchange rates of euro 263,770 thousand, included in fi- date and losses made on items realised during the year. nancial income), it can be seen that the management of exchange rate risk is essentially balanced. The item fair value measurement of currency derivatives relates to forward purchases/sales of foreign currencies The fair value measurement of other derivative in- to hedge commercial and financial transactions. For trans- struments includes euro 5,386 thousand for losses accu- actions open at the end of the year, the fair value is deter- mulated in Equity and reclassified to Income Statement at mined using the forward exchange rate at the reporting date. December 31, 2010 following unwinding of interest rate Measurement at fair value is made up of two elements: the swaps for a notional value of euro 300 million (see note 27). interest component linked to the interest rate spread be- Consolidated financial statements 153

37. INCOME TAXES

Income taxes for the year are broken down as follows:

(in thousands of euro) 2010 2009 Current taxes 150,979 80,105 Deferred taxes (13,621) 10,245 137,358 90,350

The reconciliation between theoretical taxes and effective taxes is presented below:

(in thousands of euro) 2010 2009 Income (loss) before income taxes 365,427 167,966 Reversal of net income (loss) of associates and joint ventures (256) (225) A Total Taxable Income 365,171 167,741 B Theoretical taxes 124,080 60,459 Main causes for changes between theoretical and effective taxes: —— Income not subject to taxation (39,278) (31,085) —— Non-deductible costs 42,735 54,353 —— Use of tax losses carried forward (38,764) (18,881) —— Unrecognised deferred tax assets 7,556 16,633 —— Taxes not related to income and costs for tax assessments 53,801 29,251 —— Other (12,772) (20,380) C Effective taxes 137,358 90,350 Theoretical tax rate (B/A) 34% 36% Effective tax rate (C/A) 38% 54%

The Group’s effective tax burden for 2010 (of euro The amount of taxes includes, finally, accounting by Pirelli 137,358 thousand) is attributable mainly to taxes payable & C. S.p.A. for the positive effects deriving from the option by the Tyre segment (of euro 134,429 thousand) for the for domestic tax consolidation. positive taxable incomes of its subsidiaries. It also reflects the use of tax losses carried forward and, The Group’s theoretical tax burden is calculated taking on the other hand, the existence of taxes not related to into account the nominal tax rates of the countries where income, such as the regional business tax on personnel ex- the Group’s principal companies operate, as shown below: penses in Italy (IRAP), and costs for tax assessments.

2010 2009 Europe Italy 31.40% 31.40% Spain 30.00% 30.00% Germany 29.41% 29.44% Great Britain 28.00% 28.50% Turkey 20.00% 20.00% North America USA 40.00% 40.00% South America Argentina 35.00% 35.00% Brazil 34.00% 34.00% Venezuela 34.00% 34.00% 154 Annual Financial Report at December 31, 2010 Volume 1

38. NET INCOME (LOSS) FROM DISCONTINUED OPERATIONS

The following table shows the breakdown of this item, which refers to the Real Estate and Broadband Access operating segments, which were spun off and sold, respectively, in 2010 and which qualify as discontinued operations.

(in thousands of euro) 01/01 - 09/30/2010 2009 Revenue from sales and services 295,271 403,847 Other income 22,898 43,972 Change in inventories of work in progress, semi-finished and finished goods (549) (7,778) Raw materials and supplies used (net of changes in inventories) (58,809) (26,672) Personnel expense (57,849) (104,515) Amortisation, depreciation and impairment (4,570) (12,107) Other costs (185,888) (329,026) Operating income (loss) 10,504 (32,279) Net income (loss) from equity investments (28,577) (45,135) —— share of net income (loss) from associates and joint ventures (29,522) (61,385) —— gains from equity investments 1,961 15,531 —— losses from equity investments (2,239) (81) —— dividends 1,223 800 Financial income 25,653 36,900 Financial expenses (22,961) (52,141) Net income (loss) before taxes (15,381) (92,655) Income taxes (10,223) (7,547) Net income (loss) (25,604) (100,202) Loss on Pirelli RE assignment net of selling costs (219,002) - Gain on disposal of Pirelli Broadband Access net of selling costs 20,766 - Net income (loss) from discontinued operations (223,840) (100,202)

REAL ESTATE SPIN-OFF holders’ Meeting of Pirelli & C. S.p.A. on July 15, 2010, and equal to the fair value of the investment in Pirelli On May 4, 2010 the Board of Directors of Pirelli & C. RE (now Prelios) being assigned (euro 178,813,982.89). S.p.A. resolved to submit a motion to the Shareholders That fair value had been determined on the basis of the for approval of a spin-off of the assets and activities of official price of Pirelli RE (now Prelios) shares (euro Pirelli RE (now Prelios) from the other activities oper- 0.367) quoted on July 14, 2010, the trading date prior to ated by the Pirelli Group. The purpose of this spin-off the Extraordinary Shareholders’ Meeting. was to focus Pirelli Group activities on the Tyre segment Pursuant to Article 2445(3) Italian Civil Code, the spin- in view of streamlining its operations, as part of the pro- off was completed on October 25, 2010, upon expiration gramme launched in 2008 and continued in 2009. This of the statutory term of 90 days after the resolution by programme was outlined in the 2009-2011 three-year the Extraordinary Shareholders’ Meeting of Pirelli & C. strategic business plan and aimed at focusing the Group S.p.A. had been recorded at the Companies Register. on its core industrial activities, while simultaneously al- In accordance with IFRIC 17 (Distribution of Non-cash lowing its shareholders, who already had an indirect equi- Assets to Owners), the liability resulting from the spin-off ty interest in the Real Estate segment, to acquire a direct was recalculated on the basis of the official market price investment in Pirelli RE (now Prelios). of Pirelli RE (now Prelios) shares reported on the afore- The spin-off was executed by assigning to Pirelli & C. mentioned closing date of the spin-off (euro 0.4337), S.p.A. shareholders almost all of the ordinary shares of from euro 178,813,982.89 to euro 211,312,328, with Pirelli RE (now Prelios) owned by the Company, repre- a balancing entry of euro 32,498,345 to reduce Equity. senting about 58% of the Share capital. This was carried At the same time, a loss of euro 156,268 thousand was out through a reduction in Share capital whose actual recognised in Income Statement, corresponding to the amount was determined by the Extraordinary Share- difference between the value of the liability as calculat- Consolidated financial statements 155

ed above and the carrying value of the assigned net as- quisition by ADB of 100% of the Share capital of Pirelli sets. The total impact of the assignment, a loss of euro Broadband Solutions S.p.A. (PBS), a wholly-owned sub- 219,002 thousand, is obtained by adding to the afore- sidiary of Pirelli & C. S.p.A. This transaction was complet- mentioned loss of euro 156,268 thousand the transfer to ed on November 29, 2010, with the sale by Pirelli of 100% the Income Statement of euro 32,242 thousand of losses of PBS to the ADB Group. The price paid by ADB con- that had previously been recognised in Equity, the re- sisted of about euro 25 million in cash and 400 thousand versal of a real estate gain for euro 3,660 thousand that listed shares in ADB, representing approximately 7.2% of had previously been eliminated from the consolidated its Share capital. Pirelli & C. S.p.A. agreed to a lock-up of Financial Statements, the elimination of goodwill associ- these shares for the first two months after closing, while an ated with this asset (euro 32,909 thousand) and the costs agreement for a Pirelli put option and an ADB call option connected with the spin-off (euro 1,243 thousand). was also signed, exercisable within two years. The net loss made by the Real Estate segment in the first Net of selling costs, the gain realised on the sale amounted nine months of 2010 was euro 28,986 thousand (compared to euro 20,766 thousand (with selling costs totalling euro with a net loss of euro 104,844 thousand in all of 2009). 358 thousand). The Broadband Access segment had net The spin-off resulted in the proportional assignment of income of euro 3,382 thousand in the first nine months 487,231,561 ordinary shares in Pirelli RE (now Prelios) of 2010 (compared with net income of euro 4,642 thou- to Pirelli & C. S.p.A. shareholders at a ratio of one Pirelli sand in all of 2009). RE (now Prelios) share for each Pirelli & C. S.p.A. ordinary or savings share owned, compared to a total of 487,798,972 shares owned by Pirelli & C S.p.A. prior to the spin-off. The failure to assign all the Pirelli RE (now 39. EARNINGS (LOSSES) Prelios) shares owned is entirely due to technical reasons, PER SHARE in order to determine an unfractioned ratio of assignment to the shareholders of Pirelli & C. S.p.A. Basic earnings (losses) per share are given by the ratio SALE OF BROADBAND ACCESS between net income (loss) attributable to the owners of the Parent (adjusted to take into account the minimum On October 21, 2010 Pirelli & C. S.p.A. and Advanced dividend allocated to savings shares) and the weighted Digital Broadcast Holdings SA (ADB), a company listed average of the number of ordinary shares outstanding on the Swiss stock exchange, signed an agreement for ac- during the period, with the exclusion of treasury shares.

(in thousands of euro) 2010 2009 Net income (loss) attributable to owners of the Parent from continuing operations 233,821 78,671 Net income (loss) attributable to savings shares reflecting 2% minimum dividend (5,794) (1,950) Adjusted net income (loss) attributable to owners of the Parent from continuing operations 228,027 76,721 Weighted average of outstanding ordinary shares (in thousands) 475,389 475,389 Basic earnings (losses) per ordinary share from continuing operations (in euro per thousand shares) 479.66 161.39

(in thousands of euro) 2010 2009 Net income (loss) attributable to owners of the Parent from discontinued operations (212,069) (55,926) Net income (loss) attributable to savings shares reflecting 2% minimum dividend 5,255 1,386 Net income (loss)attributable to owners of the Parent from discontinued operations (206,814) (54,540) Weighted average of outstanding ordinary shares (in thousands) 475,389 475,389 Basic earnings (losses) per share from discontinued operations (in euro per thousand shares) (435.04) (114.73)

The diluted earnings (losses) per share at December 31, 2010 have not been calculated because, following expiration of the stock option plans, the prerequisites for such calculation are not met. 156 Annual Financial Report at December 31, 2010 Volume 1

40. DIVIDENDS PER SHARE of euro 0.165 for the 475,388,592 ordinary shares (excluding the treasury shares), and euro 0.229 for In 2010, Pirelli & C. S.p.A. paid to its shareholders div- the 11,842,969 savings shares (excluding the treasury idends based on 2009 earnings equal to euro 0.0145 shares). The total dividends paid out will amount to per each of the 5,229,274,503 ordinary shares (exclud- euro 81,151 thousand. ing treasury shares) and euro 0.0406 per each of the 130,272,660 savings shares (excluding treasury shares). The total dividends paid out amounted to euro 81,114 41. HYPERINFLATION thousand. Pirelli & C. S.p.A. had not paid out any dividend in 2009. In accordance with Group accounting policies regarding the criteria for introducing/ending inflation accounting, In execution of the resolutions approved by the Extraor- the subsidiary Pirelli de Venezuela C.A. adopted infla- dinary Shareholders’ Meeting of Pirelli & C. S.p.A. on tion accounting beginning with preparation of the con- July 15, 2010, the par value of the ordinary and savings solidated financial statements at December 31, 2009. shares was eliminated on July 26, 2010, with a concur- For this purpose, a blended price index has been used: rent reverse stock split at the ratio of 1 new share for a consumer price index (IPC) covering only the cities every 11 shares owned. Therefore, following these trans- of Caracas and Maracaibo was used until December actions, there were 475,388,592 ordinary shares (ex- 31, 2007. Beginning in 2008 the Banco Central de Ven- cluding treasury shares) and 11,842,969 savings shares ezuela and the National Institute for Statistics started (excluding treasury shares). In consequence of this re- to publish a national consumer price index (Indice Na- verse stock split, the dividend for 2009 was euro 0.1595 cional de precios al consumidor - INPC) that covers the per ordinary share (excluding treasury shares) and euro entire country and uses December 2007 as its basis for 0.4466 per savings share (excluding treasury shares). calculation. For the year ended December 31, 2010, it is proposed These indices and the related conversion factors are to the Annual General Meeting that it vote a dividend presented in the table below:

Index Conversion factor December 31. 2007 100.0 1.6370 December 31. 2008 130.9 1.2506 December 31. 2009 163.7 1.2718 December 31. 2010 208.2 1.0000

The losses on the net monetary position are recognised in the income statement under the item “Financial expenses” (note 36) for an amount of euro 11,702 thousand (euro 6,495 thousand at December 31, 2009). Consolidated financial statements 157

42. RELATED PARTY Such transactions, when not carried out at standard con- TRANSACTIONS ditions or dictated by specific laws, are in any case settled on an arm’s length basis. Related party transactions, including intercompany trans- The statement below shows a summary of the Balance actions, are neither unusual nor exceptional, but are part Sheet and Income Statement items that include transac- of the ordinary course of business of Group companies. tions with related parties and their percentage impact:

(in millions of euro) Total of which % share Total of which % share reported at related reported at related 12/31/2010 parties 12/31/2009 parties BALANCE SHEET Non-current assets Other receivables 315.5 - 0.0% 557.2 395.2 70.9% Current assets Trade receivables 676.7 8.1 1.2% 735.8 91.5 12.4% Other receivables 175.0 149.8 85.6% 197.1 19.1 9.7% Non-current liabilities Other payables 41.7 - 0.0% 34.0 2.6 7.7% Current liabilities Borrowings from banks and other financial institutions 247.5 0.1 0.0% 289.3 2.5 0.9% Trade payables 1.066.4 5.4 0.5% 987.9 24.1 2.4% Other payables 403.4 1.2 0.3% 491.0 10.8 2.2% Provisions for liabilities and charges 116.0 - 0.0% 130.8 3.3 2.5% Tax payables 64.6 - 0.0% 43.9 1.1 2.5% INCOME STATEMENT Revenue from sales and services 4.848.4 5.6 0.1% 4.067.5 1.5 0.0% Other income 154.3 1.8 1.2% 147.1 - 0.0% Personnel expense (1.063.6) (5.3) 0.5% (949.2) (12.7) 1.3% Other costs (1.443.1) (23) 1.6% (1.317.2) (16.4) 1.2% Financial income 297.5 1.1 0.4% 344.8 - 0.0% Financial expenses 363.3 - 0.0% (414.9) - 0.0% 158 Annual Financial Report at December 31, 2010 Volume 1

The effects of related party transactions on the consolidated Income Statement and Balance Sheet of the Pirelli Group at December 31, 2010 are shown below. Transactions with associates and joint ventures:

RELATIONS WITH ASSOCIATES AND JOINT VENTURES (in millions of euro) Revenue from sales and services 3.7 The amount consists principally of services provided by: Pirelli Tyre S.p.A. to Sino Italian Wire Technology Co. Ltd (euro 1.9 million); Pirelli & C. Ambiente S.p.A. to Idea Granda Società Consortile r.l. (euro 0.8 million); Pirelli & C. Ambiente Site Remediation S.p.A. to Spazio Indus- triale (euro 0.4 million) Other costs 0.3 The amount refers to Corimav Consorzio for Research on Advanced Materials (euro 0.1 million). Current trade receivables 3.1 They principally refer to receivables for services provided by: Pirelli & C. Ambiente S.p.A. to Idea Granda Società Consortile r.l. (euro 0.9 million); by Pirelli Tyre S.p.A. to the associate Sino Italian Wire Technology Co. Ltd (euro 0.9 million); Pirelli Labs S.p.A to CyOptics Inc. (euro 0.4 million); Pirelli Sistemi Informativi S.r.l. to Cyoptics Inc. (euro 0.3 million) Non-current other receivables 3.4 The amount refers to receivables of Solar Utility S.p.A. from G.P. Energia S.r.l. Current financial receivables 5.9 The amount refers to receivables of: Solar Utility S.p.A. (euro 4.4 million) from the associate Solar Prometheus S.r.l.; Pirelli Tyre S.p.A. from the associate Sino Italian Wire Technology Co. Ltd (Euro 1.3 million); Pirelli & C. Ambiente S.p.A. from Serenergy S.r.l. (euro 0.2 million) Current trade payables 1.4 The amount consists principally of payables by Pirelli Labs S.p.A. (euro 1.3 million) to CyOp- tics Inc. Current other payables 1.2 The amount consists principally of payables by Solar Utility S.p.A. (euro 1.2 million) to G.P. Energia S.r.l. Borrowings from banks and other 0.1 financial institutions

TRANSACTIONS WITH PARTIES RELATED TO PIRELLI THROUGH DIRECTORS (in millions of euro) Revenue from sales and services 1.9 This refers to services provided to the Camfin Group by Pirelli & C. S.p.A. (euro 0.1 million) and by Pirelli & C. Ambiente Site Remendation S.p.A. (euro 0.9 million); to the Prelios Group by Pirelli & C. S.p.A. (euro 0.3 million) and by Centro Servizi Amministrativi Pirelli S.r.l. (euro 0.5 million) Other income 1.8 This refers principally to services provided by Pirelli Sistemi Informativi S.p.A. to the Prelios Group (euro 1.3 million) and to the Camfin Group (euro 0.2 million); and to lease income and related operating expenses of Pirelli & C. S.p.A. to Camfin S.p.A. (euro 0.2 million) and Prelios S.p.A. (euro 0.2 million) Other costs 14.1 The amount refers principally to sponsorship costs owed to F.C. Internazionale Milano S.p.A. (euro 13.7 million). Financial income 1.1 The amount refers to interest accrued on the outstanding loan to Prelios S.p.A. (euro 1.1 million). Tax 0.2 Pirelli & C.S.p.A. taxes to the Prelios group for tax consolidation. Current trade receivables 4.9 The amount refers to receivables connected with the aforementioned services to the Camfin Group (euro 1.1 million) and to the Prelios Group (euro 3.7 million) of which the following in detail: Pirelli Sistemi Informativi (euro 1.2 million); Pirelli & C. S.p.A. (euro 1.3 million); Pirelli & C. Ambiente Site Remediation S.p.A. (euro 0.6 million) Current other receivables 140.4 The amount refers to the loan to Prelios S.p.A. as part of the spin-off. Current trade payables 4.0 This amount refers mainly to the sponsorship costs mentioned above (euro 3.2 million); to payables to the Prelios Group (euro 0.7 million). Dividends paid (cash outflow) 20.8 Dividends to Camfin S.p.A. (euro 19.9 million) and C.M.C. S.p.A. (euro 0.9 million). Capital expenditure (cash outflow) 17.9 The amount refers principally to the acquisition of land and buildings in the Milan Bicocca area from Lambda S.p.A. and from Pirelli RE (now Prelios) for euro 14.2 million. Investments in other financial 1.1 This item refers to the capital increase of F.C. Internazionale Milano S.p.A. assets (cash outflow) Consolidated financial statements 159

BENEFITS FOR KEY MANAGERS average duration of debt and diversifying funding sources. OF THE COMPANY The notes has the following characteristics: —— issuer: Pirelli & C. S.p.A. At December 31, 2010, fees payable to key managers, i.e. to —— guarantor: Pirelli Tyre S.p.A. those who have the power and responsibility, directly or indi- —— amount: euro 500 million rectly, for planning, managing and controlling the business —— settlement date: February 22, 2011 of Pirelli & C. S.p.A., including executive and non-executive —— maturity date: February 22, 2016 directors, amounted to euro 13,885 thousand (euro 18,564 —— coupon: 5.125% thousand at December 31, 2009). The portion relating to —— issue price: 99.626% employee benefits was recognised in the Income Statement —— redemption price: 100% item “personnel expense” for euro 5,333 thousand of which —— minimum denomination: euro 100 thousand and ad- euro 589 thousand relating to employees’ leaving indemnity ditional whole multiples of euro 1000. (euro 12,694 thousand in 2009, of which euro 492 thousand relating to employees’ leaving indemnity) and for euro The effective yield to maturity is 5.212%, corresponding to 8,552 thousand in the Income Statement item “other costs” a yield of 230 basis points above the correspeonding refer- (euro 5,871 thousand in 2009). ence rate (mid-swap). The notes will be listed on the Lux- embourg Stock Exchange. The placement was handled by Barclays Capital, acting as global coordinator, Banca IMI, 43. SIGNIFICANT EVENTS Mediobanca, SG CIB and Unicredit as joint bookrunners. SUBSEQUENT TO THE END OF THE YEAR 44. OTHER INFORMATION

On January 13, 2011 Pirelli & C. S.p.A. sold its equity in- RESEARCH AND DEVELOPMENT EXPENSES vestment in CyOptics Inc. (34.41% shareholding) for USD 23.5 million. Research expenses rose from euro 137 million in 2009 On February 10, 2011 Pirelli & C. S.p.A. successfully (3.4% of sales) to euro 150 million in 2010 (3.1% of concluded its placement of an unrated bond issue worth a sales). They were expensed on the Income Statement in- nominal euro 500 million with international institutional sofar as they did not satisfy IFRS requirements for capi- investors on the Eurobond market. This issue was enthu- talisation. siastically received by investors, with requests totalling more than euro 4.5 billion, or over nine times the amount COMPENSATION OF DIRECTORS offered. More than 93% of the bond issue was placed with AND STATUTORY AUDITORS foreign investors. The placement, executed in accordance with the Pirelli & C. S.p.A. Board of Directors resolu- Fees paid to directors and statutory auditors of Pirelli & C. tion of July 29, 2010, is one of the actions being taken to S.p.A. for performance of their duties at the Parent and also streamline the Group debt structure by lengthening the at other consolidated companies were as follows:

(in thousands of euro) 2010 2009 Directors 8,377 7,949 Statutory Auditors 161 129 8,538 8,078 160 Annual Financial Report at December 31, 2010 Volume 1

EMPLOYEES

The average headcount of employees at consolidated companies is as follows, broken down by category:

(in thousands of euro) 2010 2009 Executives and white collar staff 6,543 6,941 Blue collar staff 20,926 20,242 Temporary workers 2,860 2,382 30,329 29,565

COMPENSATION OF INDEPENDENT AUDITORS

The following statement, prepared pursuant to Art. 149– duodecies of the Consob Issuers Regulation, shows the fees accruing to financial year 2010 for auditing services and for services other than auditing, rendered by the accounting firm Reconta Ernst & Young S.p.A. and by entities belonging to its network:

(in thousands of euro) Partial fees Total fees Independent auditing services Pirelli & C. S.p.A. 256 Subsidiaries 1,871 2,127 75.9% Certification services Pirelli & C. S.p.A. 116 Subsidiaries 123 239 8.5% Tax assistance services Pirelli & C. S.p.A. - Subsidiaries 234 234 8.3% Services other than auditing Pirelli & C. S.p.A. 170 Subsidiaries 34 204 7.3% 2,804 100%

TRANSACTIONS RESULTING FROM ATYPICAL AND/OR UNUSUAL OPERATIONS

Pursuant to Consob Notice of July 28, 2006, the Group certifies that it did not carry out any atypical and/or unusual operations in 2010, as defined in the Notice itself. Consolidated financial statements 161

EXCHANGE RATES

The main exchange rates used for consolidation purposes are as follows:

(local currency against euro) Period-end Change Average Change 12/31/2010 12/31/2009 in % 2010 2009 in % British pound 0.8608 0.8881 (3.07%) 0.8582 0.8910 (3.68%) Swiss franc 1.2504 1.4836 (15.72%) 1.3810 1.5101 (8.55%) Slovakian koruna 30.1260 30.1260 - 30.1260 30.1260 - American dollar 1.3362 1.4406 (7.25%) 1.3263 1.3941 (4.86%) Canadian dollar 1.3322 1.5128 (11.94%) 1.3657 1.5853 (13.85%) Brazilian real 2.2264 2.5084 (11.24%) 2.3334 2.7791 (16.04%) Venezuela bolivar 5.7457 6.1946 (7.25%) 5.7457 2.9973 91.70% Argentinean peso 5.3127 5.4743 (2.95%) 5.1893 5.2006 (0.22%) Australian dollar 1.3136 1.6008 (17.94%) 1.4431 1.7735 (18.63%) Chinese renminbi 8.8493 9.8367 (10.04%) 8.9785 9.5229 (5.72%) Singapore dollar 1.7136 2.0194 (15.14%) 1.8069 2.0238 (10.72%) Egyptian pound 7.7553 7.8995 (1.83%) 7.4807 7.7252 (3.16%) Turkish lira 2.0590 2.1707 (5.15%) 1.9982 2.1612 (7.54%)

NET FINANCIAL (LIQUIDITY)/DEBT POSITION (ALTERNATIVE PERFORMANCE MEASURE NOT ENVISAGED BY THE ACCOUNTING STANDARDS)

Net financial (liquidity)/debt position is broken down as follows:

(in thousands of euro) Note 12/31/2010 12/31/2009 ° of which of which related parties related parties Current borrowings from banks and other financial institutions 24 247,515 77 289,305 2,473 Current derivative financial instruments (liabilities) 27 4,810 29,598 Non-current borrowings from banks and other financial institutions 24 894,711 1,505,805 Total gross debt 1,147,036 1,824,708 Cash and cash equivalents 18 (244,725) (632,113) Securities held for trading 17 (209,770) (161,024) Current financial receivables 14 (13,266) (5,926) ** (12,477) (10,456) Current derivative financial instruments (assets) 27 (915) (3,822) Net financial debt * 678,360 1,015,272 Non-current financial receivables 14 (222,758) (486,432) (394,337) Total net financial (liquidity)/debt position 455,602 528,840

* Pursuant to Consob Notice of July 28, 2006 and in compliance with CESR recommendation of February 10, 2005 “Recommendations for the consistent implementation of the European Commission Regulation on Prospectuses” ** receivables from associates/jv ° including discontinued operations totalling euro 5,648 thousand 162 Annual Financial Report at December 31, 2010 Volume 1

Companies consolidated line-by-line Company Business Headquarters Currency Share Capital % holding Held by Europe Austria Pirelli Tyre Pirelli GmbH Tyre Vienna Euro 726,728 100.00% (Suisse) S.A. Belgium Pirelli Tyre Pirelli Tyres Belux S.A. Tyre Brussels Euro 700,000 100.00% (Suisse) S.A. France Pirelli & C. Eco Gecam France S.a.S Sustainable mobility Villepinte Euro 130,205 70.00% Technology S.p.A. Pirelli Solutions France S.a.r.l. (ex Pirelli Broadband Telecommunica- Solutions France S.a.r.l.) tions Villepinte Euro 10,000 100.00% Pirelli & C. S.p.A. Pirelli Tyre Pneus Pirelli S.a.S Tyre Villepinte Euro 1,515,858 100.00% (Suisse) S.A. Germany Deutsche Pirelli Reifen Breuberg / Holding GmbH Financial Odenwald Euro 7,694,943 100.00% Pirelli Tyre S.p.A. Drahtcord Saar Pirelli Geschaeftsfuehrungs GmbH Tyre Merzig Deut. Mark 60,000 50.00% Deutschland GmbH Drahtcord Saar Pirelli GmbH & Co. KG Tyre Merzig Deut. Mark 30,000,000 50.00% Deutschland GmbH Deutsche Driver Breuberg / Pirelli Reifen Handelssysteme GmbH Tyre Odenwald Euro 26,000 100.00% Holding GmbH Deutsche Breuberg / Pirelli Reifen Pirelli Deutschland GmbH Tyre Odenwald Euro 26,334,100 100.00% Holding GmbH Deutsche Pirelli Personal Breuberg / Pirelli Reifen Service GmbH Tyre Odenwald Euro 25,000 100.00% Holding GmbH Deutsche PK Grundstuecksverwaltungs Hoechst / Pirelli Reifen GmbH Tyre Odenwald Euro 26,000 100.00% Holding GmbH Deutsche Breuberg / Pirelli Reifen Pneumobil GmbH Tyre Odenwald Euro 259,225 100.00% Holding GmbH Greece Kallithea Pirelli Tyre Elastika Pirelli S.A. Tyre (Athens) Euro 1,192,000 99.90% (Suisse) S.A. 0.10% Pirelli Tyre S.p.A Pirelli Hellas S.A. (in liquidation) Sundry Athens US $ 22,050,000 79.86% Pirelli Tyre S.p.A. The experts in wheels – Driver hellas S.A. of marketing and trading and supply of services of development. promotion and strategic or- ganization of network in tires Kallithea and spare parts Tyre (Athens) Euro 100,000 72.00% Elastika Pirelli S.A. Hungary Pirelli Hungary Tyre Pirelli Tyre Trading and Services Ltd Tyre Budapest Hun. Forint 3,000,000 100.00% (Suisse) S.A. Ireland Pirelli Reinsurance Pirelli Finance Company Ltd Reinsurance Dublin US $ 7,150,000 100.00% (Luxembourg) S.A. Italy Centro Servizi Amministrativi Pirelli S.r.l. Services Milan Euro 51,000 67.00% Pirelli & C. S.p.A. 33.00% Pirelli Tyre S.p.A. Driver Italia S.p.A. Commercial Milan Euro 350,000 72.54% Pirelli Tyre S.p.A. EPRE S.r.l. Enviroment Milan Euro 10,000 100.00% Solar Utility S.p.A. Pirelli & C. Green&Co2 S.r.l. Enviroment Milan Euro 10,000 100.00% Ambiente S.p.A. IESS Pachino S.r.l. Enviroment Rome Euro 10,000 85.00% Solar Utility S.p.A.

Maristel S.p.A. Telecommunications Milan Euro 1,020,000 100.00% Pirelli & C. S.p.A. P.A. Società di Gestione del Pirelli & C. Risparmio S.p.A. Financial Milan Euro 2,000,000 100.00% Ambiente S.p.A. Perseo S.r.l. Services Milan Euro 20,000 100.00% Pirelli & C. S.p.A. Pirelli & C. Ambiente S.p.A. Enviroment Milan Euro 4,572,000 51.00% Pirelli & C. S.p.A. Pirelli & C. Ambiente Site Pirelli & C. Remediation S.p.A. Enviroment Milan Euro 155,700 100.00% Ambiente S.p.A. Pirelli & C. Eco Technology S.p.A. Sustainable mobility Milan Euro 17,810,000 51.00% Pirelli & C. S.p.A. Consolidated financial statements 163

Company Business Headquarters Currency Share Capital % holding Held by Europe Italy Pirelli Cultura S.p.A. Sundry Milan Euro 1.000.000 100.00% Pirelli & C. S.p.A. Pirelli Industrie Settimo Pneumatici S.r.l. Tyre Torinese (To) Euro 31,000,000 100.00% Pirelli Tyre S.p.A. Research and Pirelli Labs S.p.A. Development Milan Euro 5,000,000 100.00% Pirelli & C. S.p.A. Pirelli Nastri Tecnici S.p.A. (in liquidation) Sundry Milan Euro 384,642 100.00% Pirelli & C. S.p.A. Pirelli Servizi Finanziari S.p.A. Financial Milan Euro 1,976,000 100.00% Pirelli & C. S.p.A. Information Pirelli Sistemi Informativi S.r.l. Systems Milan Euro 1,010,000 100.00% Pirelli & C. S.p.A. Pirelli Tyre S.p.A. Tyre Milan Euro 256,820,000 100.00% Pirelli & C. S.p.A. Poliambulatorio Bicocca S.r.l. Services Milan Euro 10,000 100.00% Pirelli Tyre S.p.A. PZero S.r.l. Sundry Milan Euro 10,000 100.00% Pirelli & C. S.p.A. Servizi Aziendali Pirelli S.C.p.A. Services Milan Euro 104,000 90.25% Pirelli & C. S.p.A. 2.00% Pirelli Tyre S.p.A. Pirelli & C. 1.00% Ambiente S.p.A. Centro Servizi Amministrativi 0.95% Pirelli S.r.l. 0.95% Pirelli Labs S.p.A. Pirelli Sistemi 0.95% Informativi S.r.l. 0.95% PZero S.r.l. Pirelli & C. Eco 0.95% Technology S.p.A. Pirelli & C. Solar Utility S.p.A. Enviroment Milano Euro 14,000,000 100.00% Ambiente S.p.A. Solar Utility Sicilia S.r.l. Enviroment Milano Euro 10,000 100.00% Solar Utility S.p.A. Luxembourg Pirelli Finance (Luxembourg) S.A. Financial Luxembourg Euro 13,594,910 100.00% Pirelli & C. S.p.A. Poland Pirelli Polska Driver Polska Sp.ZO.O. Tyre Warsaw Pol. Zloty 100,000 62.00% Sp.ZO.O. Pirelli Tyre Pirelli Polska Sp.ZO.O. Tyre Warsaw Pol. Zloty 625,771 100.00% (Suisse) S.A. Romania S.C. Pirelli & C. Eco Oras Bumbesti- Pirelli & C. Eco Technology RO S.R.L. Sustainable mobility Jiu Rom. Leu 55,000,000 100.00% Technology S.p.A. S.C. Cord Romania S.R.L. Tyre Slatina Rom. Leu 36,492,150 80.00% Pirelli Tyre S.p.A. S.C. Pirelli Tyres Romania S.R.L. Tyre Slatina Rom. Leu 442,169,800 100.00% Pirelli Tyre S.p.A. Russia Pirelli Tyre OOO Pirelli Tyre Russia Commercial Moscow Russian Rouble 54,685,259 95.00% (Suisse) S.A. 5.00% Pirelli Tyre S.p.A . Slovakia Pirelli Tyre Pirelli Slovakia S.R.O. Pneumatici Bratislava Euro 6,638,78 100.00% (Suisse) S.A. Spain Pirelli Euro Driver Car S.L. Tyre Barcelona Euro 852,000 26.056% Neumaticos S.A. 26.761% Proneus S.L. Pirelli Omnia Motor S.A. Tyre Barcelona Euro 1,502,530 100.00% Neumaticos S.A. Pirelli Iniciativas Pirelli Tecnologicas S.L. Tyre Barcelona Euro 10,000 100.00% Neumaticos S.A. Pirelli Neumaticos S.A. Tyre Barcelona Euro 25,075,907 100.00% Pirelli Tyre S.p.A. Pirelli Proneus S.L. Tyre Barcelona Euro 3,005 100.00% Neumaticos S.A. Pirelli Tyre & Fleet S.L. Tyre Barcelona Euro 20,000 100.00% Neumaticos S.A. Sweden Pirelli Tyre Pirelli Tyre Nordic A.B. Tyre Bromma Swed. Krona 950,000 100.00% (Suisse) S.A. Switzerland Pirelli Société Générale S.A. Financial Basel Swiss Franc 28,000,000 100.00% Pirelli & C. S.p.A. Pirelli Tyre (Suisse) S.A. Tyre Basel Swiss Franc 1,000,000 100.00% Pirelli Tyre S.p.A. 164 Annual Financial Report at December 31, 2010 Volume 1

Company Business Headquarters Currency Share Capital % holding Held by Europe The Netherlands Pirelli China Tyre N.V. Tyre Heinenoord Euro 38,045,000 100.00% Pirelli Tyre S.p.A. Pirelli Tyre Pirelli Tyres Nederland B.V. Tyre Heinenoord Euro 18,152 100.00% (Suisse) S.A . Turkey Celikord A.S. Tyre Istanbul Turkish Lira 29,000,000 98.73% Pirelli Tyre S.p.A. Pirelli UK Tyre 0.63% Holding Ltd 0.37% Pirelli UK Tyres Ltd Pirelli Industrie 0.27% Pneumatici S.r.l. Turk-Pirelli Lastikleri A.S. Tyre Istanbul Turkish Lira 140,000,000 99.839% Pirelli Tyre S.p.A. Pirelli Industrie 0.152% Pneumatici S.r.l. Pirelli Tyre 0.009% (Suisse) S.A. United Kingdom CPC 2010 Ltd (ex CPK Auto Products Ltd) Tyre Burton on Trent British Pound 10,000 100.00% Pirelli UK Tyres Ltd CTC 1994 Ltd Tyre Burton on Trent British Pound 984 100.00% CTC 2008 Ltd CTC 2008 Ltd Tyre Burton on Trent British Pound 100,000 100.00% Pirelli UK Tyres Ltd Pirelli UK Tyre Pirelli International Ltd Financial Burton on Trent Euro 250,000,000 75.00% Holding Ltd 25.00% Pirelli Tyre S.p.A. Pirelli Motorsport Services Ltd Tyre Burton on Trent British Pound 1 100.00% Pirelli Tyre S.p.A. Pirelli Tyres Ltd Tyre Burton on Trent British Pound 16,000,000 100.00% Pirelli UK Tyres Ltd Finance Holding Pirelli UK Ltd Company Burton on Trent British Pound 97,161,278 100.00% Pirelli & C. S.p.A. Pirelli UK Tyre Holding Ltd Holding Company Burton on Trent British Pound 96,331,000 100.00% Pirelli Tyre S.p.A. Pirelli UK Tyre Pirelli UK Tyres Ltd Tyre Burton on Trent British Pound 85,000,000 75.00% Holding Ltd 25.00% Pirelli Tyre S.p.A. North America Canada Fredericton Pirelli Tyre Pirelli Tire Inc. Tyre (New Brunswich) Can. $ 6,000,000 100.00% (Suisse) S.A. U.S.A. Pirelli North America Inc. Tyre Atlanta US $ 10 100.00% Pirelli Tyre S.p.A. Wilmington Pirelli Pirelli Tire LLC Tyre (Delaware) US $ 1 100.00% North America Inc. Central/South America Argentina Pirelli Neumaticos S.A.I.C. Tyre Buenos Aires Arg. Peso 101,325,176 95.00% Pirelli Tyre S.p.A. 5.00% Pirelli Pneus Ltda Brazil Comercial e Importadora de Pneus Ltda Tyre Sao Paulo Bra. Real 12,913,526 100.00% Pirelli Pneus Ltda Cord Brasil - Industria e Comercio de Cordas para Pneumaticos Ltda Tyre Santo Andrè Bra. Real 84,784,342 100.00% Pirelli Pneus Ltda Ecosil - Industria Quimica do Brasil Ltda Tyre Meleiro Bra. Real 1,370,000 75.0 0% Pirelli Pneus Ltda Pirelli Ltda Financial Sao Paulo Bra. Real 28,000,000 100.00% Pirelli & C. S.p.A. Feira de Pirelli Pneus Ltda Tyre Santana Bra. Real 341,145,811 100.00% Pirelli Tyre S.p.A TLM - Total Logistic Management Serviços de Logistica Ltda Holding Company Santo Andrè Bra. Real 1,006,000 99.98% Pirelli Pneus Ltda Cord Brasil - Industria e Comercio de Cordas para 0.02% Pneumaticos Ltda Chile Pirelli Neumaticos Chile Limitada Tyre Santiago Chile Peso/000 1,918,451 99.98% Pirelli Pneus Ltda Comercial e Importadora de 0.02% Pneus Ltda Consolidated financial statements 165

Company Business Headquarters Currency Share Capital % holding Held by Central/South America Colombia Santa Fe Pirelli de Colombia S.A. Tyre De Bogota Col. Peso/000 3,315,069 92.91% Pirelli Pneus Ltda Pirelli de Venezuela 2.28% C.A. Cord Brasil - Industria e Comercio de Cordas para 1.60% Pneumaticos Ltda TLM - Total Logistic Management Serviços 1.60% de Logistica Ltda Comercial e Importadora de 1.60% Pneus Ltda Mexico Pirelli Neumaticos de Mexico S.A. de C.V. Tyre Mexico City Mex. Peso 35,098,400 99.98% Pirelli Pneus Ltda Comercial e Importadora 0.02% de Pneus Ltda Pirelli Neumaticos S.A. de C.V. Tyre Mexico City Mex. Peso 50,000 99.00% Pirelli Tyre S.p.A. 1.00% Pirelli Pneus Ltda Pirelli Servicios S.A. de C.V. Tyre Mexico City Mex. Peso 50,000 99.00% Pirelli Tyre S.p.A. Servicios Pirelli Mexico S.A. 1.00% de C.V. Servicios Pirelli Mexico S.A. de C.V. Tyre Mexico City Mex. Peso 50,000 99.00% Pirelli Pneus Ltda Comercial e Importadora 1.00% de Pneus Ltda Venezuela Pirelli de Venezuela C.A. Tyre Valencia Ven. Bolivar/000 20,062,679 96.22% Pirelli Tyre S.p.A. Africa Egypt Alexandria Tire Company S.A.E. Tyre Alexandria Egy. Pound 393,000,000 89.08% Pirelli Tyre S.p.A. Pirelli Tyre 0.03% (Suisse) S.A. International Tire Alexandria Tire Company Ltd Tyre Alexandria Egy. Pound 50,000 99.80% Company S.A.E. South Africa Pirelli Tyre Pirelli Tyre (Pty) Ltd Tyre Centurion S.A. Rand 1 100.00% (Suisse) S.A. Oceania Australia Pirelli Tyres Pirelli Tyre Australia Pty Ltd Tyre Sydney Aus. $ 150,000 100.00% (Suisse) S.A. New Zealand Pirelli Tyres Pirelli Tyres (NZ) Ltd Tyre Auckland N.Z. $ 100 100.00% Australia Pty Ltd Asia China Pirelli Scientific and Technological Consulting (Shangai) Co. Ltd Tyre Shangai US $ 700,000 100.00% Pirelli China Tyre N.V. Pirelli Tyre Co, Ltd Tyre Yanzhou China Renmimbi 1,210,110,000 75.00% Pirelli China Tyre N.V. Yanzhou Hixih Ecotech Pirelli & C, Eco Environment CO. Ltd Sustainable mobility Yanzhou China Renmimbi 130,000,000 60.00% Technology S.p.A. Japan Pirelli Japan Kabushiki Kaisha Tyre Tokyo Jap. Yen 2,700,000,000 100.00% Pirelli Tyre S.p.A. Singapore Pirelli Tyre Pirelli Asia Pte Ltd Tyre Singapore Sing. $ 2 100.00% (Suisse) S.A. 166 Annual Financial Report at December 31, 2010 Volume 1

Investments accounted for by the equity method Company Business Headquarters Currency Share Capital % holding Held by Europe Germany Industriekraftwerk Hoechst / Pirelli Deutschland Breuberg GmbH Cogeneration Odenwald Euro 1,533,876 26.00% GmbH Greece Elastika Eco Elastica S.A. Tyre Athens Euro 60,000 20.00% Pirelli S.A. Italy A.P.I.C.E. Pirelli & C. - società per azioni Enviroment Rome Euro 200,000 50.00% Ambiente S.p.A. Eurostazioni S.p.A. Holding Rome Euro 160,000,000 32.71% Pirelli & C. S.p.A. G.P. Energia S.r.l. Enviroment Rome Euro 1,666,667 31.00% Solar Utility S.p.A. Idea Granda Società Pirelli & C. Consortile r.l. Enviroment Cuneo Euro 1,292,500 49.00% Ambiente S.p.A. Finance Holding RCS MediaGroup S.p.A. Company Milan Euro 762,019,050 5.33% Pirelli & C. S.p.A. Pirelli & C. Serenergy S.r.l. Enviroment Milan Euro 25,500 50.00% Ambiente S.p.A. Romania S.C. Pirelli Tyres S.C. Eco Anvelope S.A. Tyre Bucarest Rom. Leu 160,000 20.00% Romania S.r.l. Spain Pirelli Signus Ecovalor S.L. Tyre Madrid Euro 200,000 20.00% Neumaticos S.A. North America U.S.A. CyOptics Inc. Photonics Breinigville US $ 631,352,501 34.41% Pirelli & C. S.p.A. Asia China Sino Italian Wire Technology Co. Ltd Tyre Yanzhou Remimbi 227,500,000 49.00% Pirelli Tyre S.p.A.

Other investments considered significant as per Consob resolution no. 11971 of May 14, 1999 Company Business Headquarters Share Capital % holding Held by Europe Belgium Euroqube S.A. (in liquidazione) Services Brussels Euro 84,861,116 17.79% Pirelli & C. S.p.A. France Aliapur S.A. Tyre Lion Euro 262,500 14.29% Pirelli Tyre S.p.A. Hungary Pirelli Hungary HUREC Tyre Recycling Public Tyre Trading and Benefit Company Tyre Budapest Hun. Forint 50,000,000 17.00% Services Ltd Italy Fin. Priv. S.r.l. Financial Milan Euro 20,000 14.29% Pirelli & C. S.p.A. Poland Centrum Utylizacji Opon Pirelli Polska Organizacja Odzysku S.A. Tyre Warsaw Pol. Zloty 1,008,000 14.29% Sp. ZO.O. Tunisia Société Tunisienne des Industries de Pnéumatiques S.A. Tyre Tunis Tun. Dinar 12,623,472 15.83% Pirelli Tyre S.p.A. United Kingdom Pirelli Finance Tlcom I Ltd Partnership Financial London Euro 1,204 10.39% (Luxembourg) S.A.

168 Annual Financial Report at December 31, 2010 Volume 1

Certification of the Consolidated Financial Statements pursuant to Article 154 bis of Legislative Decree 58 of February 24, 1998, and pursuant to Article 81-ter of Consob Regulation no. 11971 of May 14, 1999, as amended

1. The undersigned Marco Tronchetti Provera, in his capacity as Chairman of the Board of Directors, and Francesco Tanzi, in his capacity as Corporate Financial Reporting Manager of Pirelli & C. S.p.A. hereby certify pursuant to, inter alia, Article 154-bis, clauses 3 and 4, of Legislative Decree 58 of February 24, 1998: • the adequacy in relation to the characteristics of the company and • the effective application of the administrative and accounting procedures for preparation of the consolidated financial statements, during the period January 1, 2010 – December 31, 2010.

2. In this regard it should be noted that the adequacy of the administrative and accounting procedures for preparation of the consolidated financial statements for the year ended December 31, 2010 was determined on the basis of an assessment of the internal control system. This assessment was based on a specific process defined in accordance with the criteria laid down in the “Internal Control – Integrated Framework” guidelines issued by the “Committee of Sponsoring Organizations of the Treadway Commission” (COSO), which is a reference framework generally accepted at the international level.

3. We also certify that: 3.1 the consolidated financial statements: a. were prepared in accordance with the applicable international accounting standards recognised in the European Union under the terms of Regulation (EC) 1606/2002 of the European Parliament and Council, of July 19, 2002; b. correspond to the information in the account ledgers and books c. give a true and fair view of the assets, liabilities, income, expenses and financial position of the reporting entity and of the Group of companies included in the scope of consolidation. 3.2 The report on operations includes a reliable analysis of the performance and results of operations, and of the situation of the reporting entity and of the Group of companies included in the scope of consolidation, together with a description of the principal risks and uncertainties to which they are exposed.

March 8, 2011

The Chairman of the The Corporate Financial Board of Directors Reporting Manager

(Marco Tronchetti Provera) (Francesco Tanzi)

170 Annual Financial Report at December 31, 2010 Volume 1

Independent Auditor’s Report

245 246 172 Annual Financial Report at December 31, 2010 Volume 1

EXTRAORDINARY PART Extraordinary part 173

EXPLANATORY REPORT by the said Decree, the term “shareholder” has been BY THE DIRECTORS AND replaced with that of “holder of the right to vote”. In fact, under the amended Article 2370 Italian Civil PROPOSALS OF RESOLUTION Code and the new art. 83-sexies TUF, the subject who is entitled to participate in the general meeting and Report of the Board of Directors issued in accord- exercise his voting rights is no longer (only) that who, ance with Article 72, first paragraph, of Consob on the date of the meeting, is a shareholder of the Regulation No. 11971 of May 14, 1999, as amended. company but that who holds the right to vote and intervene on the so-called “record date” (i.e. “at the end Dear Shareholders, of the accounting day of the seventh trading day preceding 1. You have been convened also to attend this extraor- the date of the meeting to be held on first[or single] call”); dinary meeting to discuss our proposal regarding (i) —— since the new art. 135-novies, paragraph 6, TUF, some amendments to the Company’s By-Laws, (ii) the has introduced the possibility of «appointing a proxy voluntary reduction of the share capital by the amount of holder by electronic means» (according to rules to be € 32,498,345.12 pursuant to article 2445 of the Italian prepared by the Minister of Justice) establishing that civil code, to be allocated to stockholders’ equity; conse- «the companies indicate in their By-Laws at least one ef- quent amendments to article 5 of the By-Laws. fective method of notification by electronic means of the proxy that shareholders are entitled to use», Article 7.3 As regards the first proposal: of the new By-Laws allows for the proxy itself to be notified via: (i) a dedicated section of the Company Amendment to articles 5 (Share Capital), 7 and 8 website or (ii) certified electronic mail; (Shareholders’ Meeting), 10 and 11 (Management), —— Article 7.5 of the By-Laws has been suited to Article 16 (Board of Statutory Auditors) of the By-Laws. 126-bis TUF regarding (i) procedures and time limits Inherent and consequent resolutions. that members must comply with to put new items on the agenda, and (ii) the report on the new items 1. The reasons for the proposed which the applying members propose to discuss; amendments to the By-Laws —— the time limits (from 15 days to 25 days before the meeting) for the submission of slates for the appoint- Firstly, we wish to recall that on January 27, 2010, Leg- ment of the Board of Directors (Article 10) and of islative Decree No. 27 (the “Decree”) was approved. the Board of Statutory Auditors (Article 16) have The Decree, implementing “Directive 2007/36/EC on the been changed. exercise of certain rights of shareholders in listed companies”, At its meeting on March 8, 2011, the Board of Directors has introduced some changes into the Italian Civil Code of the Company deemed it appropriate to make further and into Legislative Decree No. 58 of February 24, 1998 amendments and additions to the By-Laws which, there- (“TUF”) with the aim of promoting the participation of fore, it now proposes to adopt. In particular, these propos- shareholders in general meetings and of facilitating the ex- als are intended to give effect to certain rights granted to ercise (including cross-border ambit) of the right to vote. companies as under the Decree. In order to fully under- It should be recalled that the shareholders’ meeting (reso- stand the proposed amendments and the reasons thereof, lution of April 21, 2010) has already incorporated in the please find below a description of the non-mandatory pro- Company’s By-Laws the right - reintroduced into the visions contained in the aforementioned Decree. Italian system by the said Decree - to call the meeting to approve the Financial Statements within 180 days after a) Provisions contained in the Decree which the end of the company’s financial year (in lieu of the we propose to adopt: previous term of 120 days). Furthermore, by virtue of the powers granted thereto (i) meetings held on single call (Article 2365, second paragraph, of the Italian Civil Code, art. 11.2 of the By-Laws), the Board of Directors The amended Article 2369 Italian Civil Code allows com- of the Company (meeting of November 3, 2010) has ap- panies to “exclude second or subsequent calls, establishing that proved some amendments to the By-Laws. In particular: the majorities indicated in the third and fourth paragraph [of —— following the entry into force of Legislative Decree art. 2369] as well as in the first paragraph, second sentence, No. 39 of January 27, 2010 (the so-called “Consoli- of art. 2368, apply to single-call ordinary meetings, while the dating Act on Legal Revision”), the term “account- majorities laid down in the seventh paragraph [of art. 2369] ing audit” has been changed into “statutory audit”; apply to single-call extraordinary meetings. In other words, —— pursuant to the so-called “record date” mechanism, companies can provide for a single call which the quorums introduced for the first time into the Italian system reported below will apply to. 174 Annual Financial Report at December 31, 2010 Volume 1

As for the ordinary meeting held on single call, this (i) will mechanism, so that the person who is entitled to partici- be duly constituted regardless of the capital represented pate in the general meeting and exercise his voting rights at the meeting, and (ii) will decide by absolute majority, is no longer (and necessarily) the person who, on the date unless the By-Laws require a higher majority (the quorums of the meeting, is a shareholder of the Company; rather, for ordinary meetings held on second call will thus apply). the person who holds the right to vote and intervene in As for the extraordinary meeting held on single call, this the meeting “at the end of the accounting day of the seventh will be duly constituted in the presence of members repre- trading day preceding the date of the meeting to be held on senting at least 1/5 of the share capital, unless the By-Laws first call”. require a higher capital share, and will decide with the fa- Given this innovative provision that substantially changes vourable vote of at least 2/3 of the share capital represent- the mechanism of entitlement to attend general meetings, ed at the meeting (the quorums for extraordinary meetings we propose to underline in the By-Laws the essential ele- held on third and subsequent calls will thus apply). ments that characterize the so-called record date in order The possibility of having a single-call meeting, with the to make it easier for shareholders to understand its con- application of the above mentioned quorums, is an op- tent. portunity to simplify the organizational activities of gen- For the same reason, we propose to underline in the By- eral meetings with potential cost savings benefits, and it Laws the main points regarding convocation of general facilitates the members’ participation in general meetings meetings and the option of putting new items on the because of the certainty as to the actual date thereof. agenda. For this reason, we propose to incorporate this option in the By-Laws, subject to the possibility for the Board of b) Further proposals to amend the By-Laws which Directors to call the general meeting more than once in we propose to adopt case of circumstances where subsequent calls to the first one are appropriate. We also propose (i) to introduce an amendment related to the Company’s adoption of the so-called “Procedure for (ii) Shareholders’ representative designated Related Party Transactions” (see explanation below) and by the company (ii) further amendments to refine the By-Laws and make them clearer, more systematic and complete, including The new art. 135-undecies TUF introduces into the Ital- minor changes of a purely terminological and/or formal ian system the so-called “designated representative”. In par- nature. ticular, unless otherwise provided in the By-Laws, “listed companies designate for each general meeting a person who * * * * * may be appointed as a proxy holder by the members by the end of the second trading day preceding the date of the meeting held For the sake of completeness, please find below the other on first or single call, with voting instructions for all or some of provisions contained in the Decree which the Board of the items on the agenda”. Directors has decided not to propose to adopt for the Although the decision as to the appointment of the “des- time being. ignated representative” for each general meeting may be completely excluded or referred to the Board of Direc- (i) voting by electronic means tors, we propose to include an express provision in the By-Laws according to which, for each general meeting, Under the new art. 2370, fourth paragraph, of the Ital- one or more persons be (necessarily) designated who may ian Civil Code, the By-Laws may provide that votes may be appointed as proxy holders by those entitled to partici- be cast by electronic means, as is already the case of pate in the general meeting, leaving it to the notice of call postal voting. to set solely the method and time limits for the issue of Given the limited success of this option in the Italian such proxy. To include this statutory provision in the By- experience and given, more importantly, the lack of a Laws underlines the importance given by the Company regulatory framework that fully and clearly regulates this to this option to intervene in the general meeting, on the issue, the Company has decided to postpone to a later one hand, and allows the shareholder to become aware of stage its assessment as to the incorporation of this right this option by merely reading the By-Laws, on the other. in the By-Laws.

(iii) “record date” and other amendments con- (ii) dividend bonus nected to the decree Pursuant to the new art. 127-quater TUF, the By-Laws As said above, the Decree has introduced for the first may provide for the possibility of awarding to “each share time into the Italian system the so-called “record date” held by the same shareholder for an uninterrupted period Extraordinary part 175

[…] of not less than one year” the “right to a bonus of up Given that the general meeting that is called to approve to 10 per cent of the dividend awarded to the other shares”. the Financial Statements at December 31, 2010 is also This benefit is limited to those who (directly or indirect- required to decide on the renewal of the Board of Direc- ly) have a shareholding that does not exceed 0.5% of the tors which has lost office due to expiry of its term, it is company’s capital (or the lower percentage indicated in essential to give the following information. the By-Laws). According to Article 10, fifth paragraph, of the By-Laws, The bonus cannot be attributed to (i) the shares held by slates may be submitted only by members who, either those who during the said period have exercised, even alone or together with other members, hold shares repre- temporarily or together with other members through a senting at least 2% of the share capital with voting rights shareholders’ agreement, a dominant influence or signifi- in the ordinary shareholders’ meeting, or the minor per- cant influence over the company, (ii) the shares that have centage required by the regulations issued by Consob been transferred, even temporarily, to a shareholders’ which, for the year 2011, was 1. 5% of the share capital agreement concerning a total shareholding of more than (cfr. Consob Resolution No. 17633 of 26/01/2011). 0.5% (or the lower percentage indicated in the By-Laws). The Board has deemed it appropriate not to propose to The uncertainty that currently arises from the relevant reduce the percentage established by the By-Laws in or- regulatory framework and the difficulties encountered in der to align it with that established by Consob since, on applying in practice the dividend bonus mechanism (not the one hand, the current formulation is already designed least, the difficulty of identifying the persons entitled to to facilitate the submission of slates by minorities for the the bonus), have induced the Board to postpone its evalu- renewal of Management bodies (establishing in any case ation to a later stage. a “cap” to the percentage required for the presentation of minority slates which, in any case, may be reduced ac- (iii) identification of shareholders cording to an assessment of the parameters set by Con- sob, among which market capitalization) and, on the Under the new art. 83-duodecies TUF “where provided by other hand, this allows for the By-Laws provision to be the By-Laws, Italian [listed] companies may ask intermedi- adequately flexible. aries, at any time and at the former’s own cost and through a central management company, for the identification data * * * * * of shareholders who have not expressly prohibited disclosure thereof, together with the number of shares registered in their The following paragraphs describe in detail the amend- accounts”. ments indicated above with reference to the single articles Where the By-Laws provide for this option, “the company of the By-Laws. must make this request upon the demand of members representing half the minimum shareholding set by Consob” for the article 5 (share capital) submission of slates for the appointment of the management, and “costs are shared between the company and The current Article 5, fourth paragraph, gives evidence the requesting members according to criteria established (i) of the resolution adopted by the extraordinary share- by Consob”. holders’ meeting of May 7, 2003 by which Directors In this latter regard, please note that the so-called Issu- were authorized to issue, on one or more occasions, up ers’ Regulations establish that “if the right [to identify to a maximum of 100,000,000 ordinary shares to be allo- shareholders] is exercised by members within six months of cated to executive managers and cadres of the company year-end and in any case before the annual ordinary meeting and its subsidiaries, and (ii) of the resolution adopted by and no request for identification is made in the same period the Board of Directors, in partial implementation of the […], the company shall bear the full cost of disclosure of the authorization granted to it, to increase the share capital shareholder’s identification data and of the number of shares by issuing new ordinary shares to be reserved for sub- registered in their accounts”. scription to executive managers and cadres of the com- Given (i) the absence of rules establishing, in a clear and pany and its subsidiaries. comprehensive way, the concrete method which inter- Having expired the authorization granted by the share- mediaries must follow to determine the disclosure costs holders’ meeting on May 7, 2003 and being terminat- borne by issuers and (ii) the current shareholding struc- ed the stock option plans by which, as resolved by the ture of the Company that is “nominally” public for more Board of Directors, the share capital increase has been than 50% of the share capital, the Board has decided to inplemented as under point (ii), we propose to fully postpone its decision on the implementation of this right amend the said paragraph 4 and thereby re-number the to a later stage. current paragraph 5.

* * * * * 176 Annual Financial Report at December 31, 2010 Volume 1

article 7 (shareholders’ meetings) in terms of “information to the public about related-party transactions”. For the reasons outlined above, we propose to revise par- Therefore, we propose to introduce a new paragraph 3 agraph 2 of Article 7 of the By-Laws establishing that the which allows for the enforcement of this option. Board of Directors may provide for the meeting to be Hence, we also propose to re-number the subsequent held on single call or on more calls. paragraphs of Article 11. In the same article, we also propose to revise: (i) in part and to supplement paragraph 3 of Article 7 Article 16 (Board of Statutory Auditors) in order to incorporate art. 135-undecies, paragraph 1 TUF, on the designation of the representative who The proposed amendments concern the re-wording of may be appointed as a proxy holder with voting in- paragraph 7, taking into account the provisions of art. structions by those entitled to vote; 144-sexies of the Issuers’ Regulations and art. 147-ter (ii) paragraph 5 and to add the “new” paragraphs 6, 7, TUF) about disclosure of the slates presented by the 8 and 9, which reaffirm the essential elements of shareholders to appoint the Statutory Auditors candi- the reformed regulations on the convocation of the dates. general meeting and on the right to put new items Further amendments proposed in relation to Article 16 on the agenda. As a result of these amendments, we are (i) designed to foster greater explanatory clarity, and/ propose to re-number paragraph 6 as paragraph 10. or of a purely formal nature or (ii) due to other changes proposed in this report (in particular, also in this case, the article 8 (shareholders’ meetings) inclusion in paragraph 7 of the reference to the general meeting held on single call). As stated above, the proposed amendments consist of introducing paragraphs 3, 4, 5 and 6, which state again 2. Compared illustration of the articles the provisions of Art. 83-sexies TUF regarding the entitle- of the By-Laws which we propose ment to attend the general meeting and the exercise of to amend voting rights (the so-called “record date”). The comparison between the current articles of the By- Article 10 (Administration of the company) Laws which we propose to amend and those which we submit for your approval is contained in the following The proposed amendments to Article 10 are (i) designed resolution proposal. to foster greater explanatory clarity, and/or of a purely formal nature or (ii) due to other changes proposed in 3. Evaluation by the Board of Directors this report (in particular, the inclusion in paragraph 3 of as to the potential enforceability of the reference to the general meeting held on single call). the right of withdrawal

Article 11 (Administration of the company) The Board of Directors believes that the amendments to the By-Laws described above do not give rise to the right On November 3, 2010, the Board of Directors approved a of withdrawal as under Article 2437 Italian Civil Code. new “Procedure for Related-Party Transactions”, published on the Company website in compliance with the prescriptions 4. Resolution proposal on this issue contained in the “Regulation of related-party transactions”, adopted by Consob Resolution No. 17221 of Based on the foregoing, the Board of Directors submits March 12, 2010, as amended by Consob Resolution No. the following resolution proposals for your approval: 17389 of June 23, 2010, taking into account the guidelines and clarifications provided by Consob in its Communica- “The extraordinary shareholders’ meeting of Pirelli & C. tion No. DEM/10078683 of September 24, 2010. S.p.A., This Procedure includes the possibility (under article 13, —— having examined the Directors’ Report explain- sixth paragraph, of the said Regulation issued by Con- ing the proposed amendments to Articles 5 (Share sob), in case of urgent matters, to enter into transactions capital), 7 and 8 (Shareholders’ meetings), 10 and with related parties of greater or lesser importance (as de- 11 (Administration of the company), 16 (Board of fined in the Procedure) by derogating from the respective Statutory Auditors) of the By-Laws; authorization processes required therefor, provided this is allowed by the By-Laws and in cases where the transaction does not pertain to the Shareholders’ meeting and needs not be approved thereby, subject to the obligations Extraordinary part 177

RESOLVES

1. to amend Articles 5 (Share capital), 7 and 8 (Share- holders’ meetings), 10 and 11 (Administration of the company), 16 (Board of Statutory Auditors) of the By-Laws of Pirelli & C. S.p.A. as follows:

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Article 5 Article 5

5.1 The Company shall have a subscribed and paid-in 5.1 The Company shall have a subscribed and paid-in share capital of EUR 1,377,878,879.78 (onebil- share capital of EUR 1,377,878,879.78 (onebil- lionthreehundredandseventysevenmillioneight- lionthreehundredandseventysevenmillioneight- hundredandseventyeightthousandeighthundred- hundredandseventyeightthousandeighthundred- seventyninepointseventyeight) divided into no. seventyninepointseventyeight) divided into no. 487,991,493 (fourhundredeightysevenmillion- 487,991,493 (fourhundredeightysevenmillion- ninehundredninetyonethousandfourhundredni- ninehundredninetyonethousandfourhundredni- netythree) shares without par value consisting of netythree) shares without par value consisting of 475,740,182 (fourhundredseventyfivemillionsev- 475,740,182 (fourhundredseventyfivemillionsev- enhundredfortythousandonehundredeighty) ordi- enhundredfortythousandonehundredeighty) ordinary shares and 12,251,311 (twelvemilliontwohun- nary shares and 12,251,311 (twelvemilliontwohun- dredfiftyonethousandthreehundred-eleven) savings dredfiftyonethousandthreehundred-eleven) savings shares. shares. 5.2 In resolutions to increase the share capital by issu- 5.2 In resolutions to increase the share capital by issuing shares against payment, pre- emption right may ing shares against payment, pre- emption right may be excluded for up to a maximum of ten percent be excluded for up to a maximum of ten percent of the previously existing capital, provided that the of the previously existing capital, provided that the issue price corresponds to the market value of the issue price corresponds to the market value of the shares and that this is confirmed in a specific re- shares and that this is confirmed in a specific report prepared by the firm appointed to audit the port prepared by the firm appointed to audit the accounts. accounts. 5.3 If so resolved by the shareholders’ meeting, the 5.3 If so resolved by the shareholders’ meeting, the share capital may also be increased by means of share capital may also be increased by means of contributions in kind or of receivables. contributions in kind or of receivables. 5.4 By resolution of the extraordinary shareholders’ meeting held on May 7, 2003, the directors were authorised to issue, on one or more occasions within April 30, 2008, up to a maximum of 100,000,000 ordinary shares, to be allocated to executive managers and cadres employed by the Company, by its subsidiaries and by the subsidiaries of the latter, in Italy and abroad, in compliance with article 2441, paragraph 8, of the Italian Civil Code and article 134 of Legislative Decree no. 58/1998. On February 25, 2005 the Board of Directors resolved, in partial implementation of the authorisation granted to it by the extraordi- 178 Annual Financial Report at December 31, 2010 Volume 1

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nary shareholders’ meeting held on May 7, 2003, to increase the share capital by a maximum nominal amount of EUR 15,725,496.50, re-determined as EUR 15,725,494.18 after the reverse stock split in a ratio of 1 new share for every 11 ordinary or savings shares held, resolved by the extraordinary shareholders meeting held on July 15, 2010, by issuing, taking account of said reverse stock split and of the reduction of share capital through assignment of Pirelli & C. Real Estate S.p.A. shares resolved by the extraordinary shareholders’ meeting held on July 15, 2010, a maximum of 4,929,622 ordinary shares without par value, at a price of EUR 10.589 per share, inclusive of a EUR 7.399 share premium and EUR 3.190 to impute to capital, to be reserved for subscription by executive managers and cadres employed by the Company, 5.4 If resolved by the Shareholders’ Meeting, the share by its subsidiaries and by the latter’s subsidiaries, capital may be reduced also by assignment of non- in Italy and abroad. cash assets to the shareholders. 5.5 If resolved by the Shareholders’ Meeting, the share capital may be reduced also by assignment of non- cash assets to the shareholders.

Article 7 Article 7

7.1 The calling of shareholders’ meetings, which may 7.1 The calling of shareholders’ meetings, which may be held anywhere in Italy, including in a place oth- be held anywhere in Italy, including in a place other than the Company’s registered office, the right er than the Company’s registered office, the right to attend meetings and representation at same are to attend meetings and representation at same are all regulated by law and by these By-laws. all regulated by law and by these By-laws. 7.2 The notice of call of an extraordinary shareholders’ 7.2 The notice of call of the meeting may provide for it meeting may provide for it being held on third call. being held on single call or on first and second call and, in case of an extraordinary shareholders’ meeting, also on third call. The corresponding resolutions are adopted by the majorities required by law for meetings held on single call or on different calls. 7.3 Persons with voting rights are entitled to attend the 7.3 Persons with voting rights may appoint a repre- meeting and may appoint a representative by proxy sentative by proxy issued as provided by the cur- issued as provided by the current law and regula- rent law and regulations. tions. The proxy may be notified to the Company by The proxy may be notified to the Company by electronic means, making alternative use of one of electronic means, making alternative use of one of the following methods: the following methods: a) use of the dedicated section of the Company a) use of the dedicated section of the Company website, indicated by the Company in the notice website, indicated by the Company in the notice of call; of call; b) dispatch of a message to the certified electron- b) dispatch of a message to the certified electronic mail address at the address indicated by the ic mail address at the address indicated by the Company in the notice of call. Company in the notice of call. The notice of call may also circumscribe the meth- The notice of call may also circumscribe the method to be used for the specific shareholders’ meet- od to be used for the specific shareholders’ meeting ing to which the notice refers to one of the afore- to which the notice refers to one of the aforemen- mentioned methods. tioned methods. The Company designates, for each general meeting, one or more persons who may be Extraordinary part 179

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appointed as a proxy holder by those entitled to vote at the meeting, with voting instructions for all or some of the items on the agenda. The proxy has no effect with respect to the items for which no voting instructions have been given. The designated proxy holders, the method and time limits for the issue of prox- ies are set in the notice of call. 7.4 The ordinary shareholders’ meeting must be called 7.4 The ordinary shareholders’ meeting must be called in accordance with the law within a maximum of in accordance with the law within a maximum of 180 days after the end of the Company’s financial 180 days after the end of the Company’s financial year. year. 7.5 Requests to add items to the agenda of the general 7.5 The directors, in the cases and manners pro- meetings presented by shareholders in accordance vided by law, must forthwith call the general with the law must be detailed, by the same share- meeting when this is required by members holders, with a report to the Board of Directors representing at least a twentieth of the share filed at the Company’s registered office before the capital. last date indicated for submission of the request for additions to be made to the agenda. 7.6 The members who require the meeting to be called prepare a report on the proposed items to be discussed. The Board of Directors, together with the publication of the notice of call and in the manner prescribed by law, makes available to the public the report prepared by the members, along with its potential assessment thereof. 7.7 The members who, even together, represent at least one fortieth of the share capital may ask, in the cases and in the manner prescribed by law, to add items to the agenda, specifying in their request the new items proposed thereby. 7.8 The new items submitted under paragraph 7 of Article 7 of these By-Laws, are published, according to the provisions of law, in the same manner prescribed for the publication of the notice of call. 7.9 The members who ask to put new items on the agenda prepare a report on the items which they propose to discuss, and deliver it to the Board of Directors by filing it at the Company’s offices before the last date indicated for submission of the request for additions to be made to the agenda. The Board of Directors, simoultaneously to the publication of the notice of additions to the agenda and in the manner prescribed by law, makes available to the public the report prepared by the members, along with its potential assessment thereof. 7.6 Special meetings of savings shareholders shall be 7.10 Special meetings of savings shareholders shall be convened by the common representative of savings convened by the common representative of savings shareholders or by the Board of Directors of the shareholders or by the Board of Directors of the Company whenever they deem necessary or in ac- Company whenever they deem necessary or in accordance with the law. cordance with the law.. 180 Annual Financial Report at December 31, 2010 Volume 1

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Article 8 Article 8

8.1 The due constitution of shareholders’ meetings 8.1 The due constitution of shareholders’ meetings and the validity of the resolutions adopted by same and the validity of the resolutions adopted by same are governed by law. are governed by law. 8.2 The proceedings of shareholders meetings are gov- 8.2 The proceedings of shareholders meetings are governed by law, by these By-laws, and – solely for the erned by law, by these By-laws, and – solely for the ordinary and extraordinary general meetings – by ordinary and extraordinary general meetings – by the Rules of Proceeding approved by resolution of the Rules of Proceeding approved by resolution of the Company’s ordinary shareholders meeting. the Company’s ordinary shareholders meeting. 8.3 The right to attend the general meeting and to exercise voting rights is governed by the applicable provisions of law. 8.4 The right to attend the general meeting and to exercise voting rights is certified by a notice given to the Company by the authorized intermediary, in accordance with its accounting records, in favour of the person who is entitled to vote. 8.5 The notice referred to in paragraph 4 of Ar- ticle 8 of these By-Laws is given by the intermediary on the basis of evidence relating to the end of the accounting day of the seventh trading day preceding the date of the meeting to be held on first or single call. The credit and debit recordings made on the accounts after that term are not relevant for the purposes of the right to exercise voting rights at the general meeting. 8.6 The notice referred to in paragraph 4 of Ar- ticle 8 of these By-Laws must be received by the Company by the end of the third trading day preceding the date of the meeting to be held on first or single call or within the different deadline established by the applicable regulations. This is without prejudice to the right to participate in the meeting and to vote where the notice referred to in paragraph 4 of Article 8 of these By-Laws is received by the Company after the deadline specified in this paragraph though prior to the beginning of the meeting held on single call.

Article 10 Article 10

10.1 The Company shall be managed by a Board of Di- 10.1 The Company shall be managed by a Board of Di- rectors composed of no less than seven and no more rectors composed of no less than seven and no more than twenty three members who shall remain in of- than twenty three members who shall remain in office for three financial years (unless the sharehold- fice for three financial years (unless the shareholders’ meeting establishes a shorter term at the time of ers’ meeting establishes a shorter term at the time of their appointment) and may be re-elected. their appointment) and may be re-elected. The shareholders’ meeting shall establish the number The shareholders’ meeting establishes the number of of members of the Board of Directors, which shall re- members of the Board of Directors, which remains main unchanged until said meeting resolves otherwise. unchanged until said meeting resolves otherwise. Extraordinary part 181

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10.2 The Board of Directors shall be appointed on the 10.2 The Board of Directors is appointed on the basis of basis of slates presented by the shareholders pursu- slates presented by the shareholders pursuant to the ant to the following paragraphs hereof, in which the following paragraphs hereof, in which the candidates candidates are listed by consecutive number. are listed by consecutive number. 10.3 The slates presented by the shareholders, which 10.3 The slates presented by the shareholders, which must be undersigned by the parties submitting must be undersigned by the parties submitting them, shall be filed at the Company’s registered of- them, must be filed at the Company’s registered office, and be available at least twenty five days before fice, and be available at least twenty five days before the date set for the shareholders’ meeting to be held the date set for the shareholders’ meeting to be held on first call. They are made available to the public at on first or single call that is required to decide the registered office, on the Company website and upon the appointment of the members of the in the other ways specified by Consob regulations at Board of Directors. They are made available to least 21 days before the date of the general meeting. the public at the registered office, on the Company website and in the other ways specified by Consob regulations at least 21 days before the date of the general meeting. 10.4 Each shareholder may present or take part in the 10.4 Each shareholder may present or take part in the presentation of only one slate and each candidate presentation of only one slate and each candidate may appear on only one slate on pain of ineligibility. may appear on only one slate on pain of ineligibility. 10.5 Only shareholders who, alone or together with other 10.5 Only shareholders who, alone or together with other shareholders, hold a total number of shares repre- shareholders, hold a total number of shares representing at least 2 percent of the share capital entitled senting at least 2 percent of the share capital entitled to vote at the ordinary shareholders’ meeting or the to vote at the ordinary shareholders’ meeting or the minor percentage, according to the regulations is- minor percentage, according to the regulations issued by Commissione Nazionale per le Società e la sued by Commissione Nazionale per le Società e la Borsa, are entitled to submit slates, subject to their Borsa, are entitled to submit slates, subject to their proving ownership of the number of shares needed proving ownership of the number of shares needed for the presentation of slates within the term speci- for the presentation of slates within the term specified for their publication by the Company. fied for their publication by the Company. 10.6 Together with each slate, and within the respective 10.6 Together with each slate, statements must be terms specified above, statements must be filed in filed in which the individual candidates agree which the individual candidates agree to their nomi- to their nomination and attest, under their own nation and attest, under their own liability, that there liability, that there are no grounds for their in- are no grounds for their ineligibility or incompatibil- eligibility or incompatibility, and that they meet ity, and that they meet any requisites prescribed for any requisites prescribed for the positions. To- the positions. Together with such statements, a cur- gether with such statements, a curriculum vi- riculum vitae must be filed for each candidate, set- tae must be filed for each candidate, including ting out their relevant personal and professional data their relevant personal and professional data and and mentioning the offices held in management and mentioning the offices held in management and supervisory bodies of other companies and specify- supervisory bodies of other companies and their ing, where appropriate, the grounds on which they satisfaction of the requisites of independence qualify as an independent candidate in accordance prescribed for directors of listed companies with the criteria established by law and the Com- by the law or by the governance code endorsed pany. Any changes that occur up to the date of the by the Company. Any changes that occur up to Shareholders’ meeting must be promptly notified to the date of the Shareholders’ meeting must be the Company. promptly notified to the Company. 10.7 Any slates submitted without complying with the 10.7 Any slates submitted without complying with the foregoing provisions shall be disregarded. foregoing provisions shall be disregarded. 10.8 Each person entitled to vote may vote for only one 10.8 Each person entitled to vote may vote for only one slate. slate. 10.9 The Board of Directors shall be elected as specified 10.9 The Board of Directors is elected as specified be- below: low: a) four-fifths of the directors to be elected shall be a) four-fifths of the directors to be elected are cho- chosen from the slate which obtains the highest sen from the slate which obtains the highest number of votes cast by the shareholders, in the number of votes cast by the shareholders, in the 182 Annual Financial Report at December 31, 2010 Volume 1

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order in which they are listed on the slate; in the order in which they are listed on the slate; in the event of a fractional number, it shall be rounded- event of a fractional number, it is rounded-down down to the nearest whole number; to the nearest whole number; b) the remaining directors shall be chosen from the b) the remaining directors are chosen from the oth- other slates; to this end, the votes obtained by er slates; to this end, the votes obtained by the the various slates shall be divided by whole pro- various slates are divided by whole progressive gressive numbers from one up to the number of numbers from one up to the number of directors directors to be elected. to be elected. The quotients thus obtained are as- The quotients thus obtained shall be assigned to signed to the candidates on each slate in the order the candidates on each slate in the order they are they are respectively listed thereon. On the basis respectively listed thereon. On the basis of the quo- of the quotients assigned, the candidates on the tients assigned, the candidates on the various slates various slates are ranked in a single list in decreas- shall be ranked in a single list in decreasing order. ing order. Those who have obtained the highest Those who have obtained the highest quotient shall quotient are elected. be elected. If more than one candidate obtains the If more than one candidate obtains the same quo- same quotient, the candidate from the slate that tient, the candidate from the slate that has not yet has not yet elected a director or that has elected elected a director or that has elected the lowest the lowest number of directors shall be elected. If number of directors is elected. none of such slates has as yet elected a director or If none of such slates has as yet elected a director they have all elected the same number of directors, or they have all elected the same number of direc- the candidate from the slate which obtained the tors, the candidate from the slate which obtained the highest number of votes shall be elected. If the dif- highest number of votes is elected. If the different ferent slates obtain the same number of votes and slates obtain the same number of votes and their their candidates are assigned the same quotients, a candidates are assigned the same quotients, a new new vote shall be held by the entire shareholders’ vote is held by the entire shareholders’ meeting and meeting and the candidate who obtains the simple the candidate who obtains the simple majority of the majority of the votes shall be elected. votes is elected. 10.10 If the application of the slate voting system shall 10.10 If the application of the slate voting system shall not ensure the appointment of the minimum not ensure the appointment of the minimum number of independent Directors required by the number of independent Directors required by the law and/or regulation, the appointed non-inde- law and/or regulation, the appointed non-independent candidate indicated with the higher pro- pendent candidate indicated with the higher progressive number in the slate which has obtained gressive number in the slate which has obtained the higher number of votes shall be replaced by the the higher number of votes is replaced by the non- non-appointed independent candidate included in appointed independent candidate included in the the same slate on the basis of the progressive order same slate on the basis of the progressive order of of the presentation and so on, slate by slate, until the presentation and so on, slate by slate, until the the minimum number of independent Directors minimum number of independent Directors shall shall be appointed. be appointed. 10.11 When appointing directors who, for whatsoever 10.11 When appointing directors who, for whatsoever reason were not appointed under the procedure reason were not appointed under the procedure established herein, the shareholders’ meeting shall established herein, the shareholders’ meeting shall vote on the basis of the majorities required by law. vote on the basis of the majorities required by law. 10.12 If one or more vacancies occur on the Board dur- 10.12 If one or more vacancies occur on the Board during the course of the financial year, the procedure ing the course of the financial year, the procedure established in article 2386 of the Italian Civil Code established in article 2386 of the Italian Civil Code shall be followed. shall be followed. 10.13 In the event a Director cease to comply with the 10.13 In the event a Director cease to comply with the independence requirements, this does not cause independence requirements, this does not cause his/her ceasing to be a Director provided that the his/her ceasing to be a Director provided that the Directors in office complying with legal independ- Directors in office complying with legal independence requirements are a number at least equal to ence requirements are a number at least equal to the minimum number requested by laws and/or the minimum number requested by laws and/or regulations. regulations. Extraordinary part 183

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10.14 The Board of Directors shall elect its own Chair- 10.14 The Board of Directors shall elect its own Chair- man, if the shareholders’ meeting has not already man, if the shareholders’ meeting has not already done so, and may also appoint one or more Deputy done so, and may also appoint one or more Deputy Chairmen. Chairmen. 10.15 In the absence of the Chairman, a Deputy Chair- 10.15 In the absence of the Chairman, a Deputy Chair- man or a Managing Director, in that order, shall act man or a Managing Director, in that order, shall act in his/her stead; should there be two or more Deputy in his/her stead; should there be two or more Deputy Chairmen or Managing Directors, the Board shall Chairmen or Managing Directors, the Board shall be presided over by the elder of same respectively. be presided over by the elder of same respectively. 10.16 The Board of Directors shall appoint a Secretary, 10.16 The Board of Directors shall appoint a Secretary, who need not be a director. who need not be a director. 10.17 Until the shareholders’ meeting resolves otherwise, 10.17 Until the shareholders’ meeting resolves otherwise, the directors shall not be subject to the prohibition the directors shall not be subject to the prohibition contemplated in article 2390 of the Italian Civil contemplated in article 2390 of the Italian Civil Code. Code.

Article 11 Article 11

11.1 The Board of Directors shall conduct the man- 11.1 The Board of Directors shall conduct the manage- agement of the company and is accordingly vested ment of the company and is accordingly vested with the broadest powers of administration, except with the broadest powers of administration, except for those remitted by law or by these By-laws to for those remitted by law or by these By-laws to the the authority of the shareholders’ meeting. authority of the shareholders’ meeting. 11.2 Within the limits established by law, the Board 11.2 Within the limits established by law, the Board of Directors shall be authorised to decide on the of Directors shall be authorised to decide on the merger of companies in Pirelli & C. S.p.A. or de- merger of companies in Pirelli & C. S.p.A. or de- merger in favour of Pirelli & C. S.p.A of compa- merger in favour of Pirelli & C. S.p.A of companies in which Pirelli & C. S.p.A. owns at least 90 nies in which Pirelli & C. S.p.A. owns at least 90 percent of the shares or quotas, the reduction of percent of the shares or quotas, the reduction of the share capital in the event of the withdrawal of the share capital in the event of the withdrawal of shareholders, the revision of the By-laws to con- shareholders, the revision of the By-laws to con- form with statutory provisions, the relocation of form with statutory provisions, the relocation of the Company’s registered office within Italy, and the Company’s registered office within Italy, and the opening and closing of branch offices. the opening and closing of branch offices. 11.3 In case of urgent matters, transactions with related parties of greater or lesser importance, as defined in the Procedure for related-party transactions adopted by the Board of Directors of the Company, which do not pertain to the shareholders’ meeting and need not be approved thereby, may be entered into also by derogating from the respective authorization processes required in the Pro- cedure, as long as this happens at the terms laid down therein. 11.3 The Board of Directors and the Board of Statutory 11.4 The Board of Directors and the Board of Statutory Auditors shall be kept informed, also by corporate Auditors shall be kept informed, also by corporate bodies with delegated powers, on the activities car- bodies with delegated powers, on the activities carried out, the general performance of operations ried out, the general performance of operations and their foreseeable development, and the trans- and their foreseeable development, and the transactions of greatest economic, financial and equity- actions of greatest economic, financial and equity- related significance concluded by the Company or related significance concluded by the Company or its subsidiaries; in particular, said corporate bodies its subsidiaries; in particular, said corporate bodies with delegated powers shall report on transactions with delegated powers shall report on transactions in which they have an interest, directly or on behalf in which they have an interest, directly or on be- 184 Annual Financial Report at December 31, 2010 Volume 1

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of third parties, or that are influenced by the party half of third parties, or that are influenced by the that performs management and coordination ac- party that performs management and coordina- tivities, if any. Such reports shall be made prompt- tion activities, if any. Such reports shall be made ly, on a quarterly basis at the least, in a written promptly, on a quarterly basis at the least, in a memorandum. written memorandum. 11.4 In accordance with the established times and pro- 11.5 In accordance with the established times and procedures for disclosing information to the market, cedures for disclosing information to the market, the representative of the holders of savings shares the representative of the holders of savings shares must be informed by the Board of Directors or by must be informed by the Board of Directors or by the persons delegated for such purpose about any the persons delegated for such purpose about any corporate events that might affect the price of the corporate events that might affect the price of the shares in that class. shares in that class. 11.5 In the context of the management of the Company, 11.6 In the context of the management of the Compa- the Board of Directors shall be authorised to del- ny, the Board of Directors shall be authorised to egate those powers which it deems appropriate to delegate those powers which it deems appropriate one or more of its members, possibly with the title to one or more of its members, possibly with the of Managing Director, and grant them the single title of Managing Director, and grant them the sin- or joint signature powers it decides appropriate to gle or joint signature powers it decides appropriate establish. to establish. 11.6 It may also delegate its powers to an Executive 11.7 It may also delegate its powers to an Executive Committee composed of some of its own mem- Committee composed of some of its own members, whose remuneration shall be established by bers, whose remuneration shall be established by the shareholders’ meeting. the shareholders’ meeting. 11.7 It may also establish one or more committees with 11.8 It may also establish one or more committees with consulting and propositional functions, also for consulting and propositional functions, also for purposes of adjusting the corporate governance purposes of adjusting the corporate governance structure in line with the recommendations issued structure in line with the recommendations issued from time to time by the pertinent authorities. from time to time by the pertinent authorities. 11.8 The Board of Directors shall appoint - with the 11.9 The Board of Directors shall appoint - with the consent of the Board of Statutory Auditors - the consent of the Board of Statutory Auditors - the manager responsible for preparing the Company’s manager responsible for preparing the Company’s financial reports. His office shall expire at the same financial reports. His office shall expire at the same time as that of the Board of Directors that appoint- time as that of the Board of Directors that appointed him/her, unless annulment for good cause, with ed him/her, unless annulment for good cause, with the consent of the Board of Statutory Auditors. the consent of the Board of Statutory Auditors. 11.9 The manager responsible for preparing the Com- 11.10 The manager responsible for preparing the Com- pany’s financial reports must be an expert on ad- pany’s financial reports must be an expert on administration, finances and auditing of companies ministration, finances and auditing of companies and satisfy the integrity qualifications required to and satisfy the integrity qualifications required to be a directors. Failing of such qualifications shall be a directors. Failing of such qualifications shall determine the termination of the office to be re- determine the termination of the office to be resolved by the Board of Directors within thirty days solved by the Board of Directors within thirty days since the acknowledgement of the defect. since the acknowledgement of the defect. 11.10 Lastly, the Board may appoint general managers, 11.11 Lastly, the Board may appoint general managers, deputy general managers, managers and deputy deputy general managers, managers and deputy managers and attorneys-in-fact to carry out certain managers and attorneys-in-fact to carry out certain operations or categories of operations, establishing operations or categories of operations, establishing their powers and functions. The appointment of their powers and functions. The appointment of managers, deputy managers and attorneys-in-fact managers, deputy managers and attorneys-in-fact to carry out certain operations or categories of op- to carry out certain operations or categories of operations may also be remitted by the Board to the erations may also be remitted by the Board to the Managing Directors and the General Managers. Managing Directors and the General Managers. Extraordinary part 185

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Article 16 Article 16

16.1 The Board of Statutory Auditors shall be composed 16.1 The Board of Statutory Auditors shall be composed of of three standing and two alternate auditors, who three standing and two alternate auditors, who must must be in possession of the requisites established un- be in possession of the requisites established under der applicable laws and regulations; to this end, it shall applicable laws and regulations; to this end, it shall be borne in mind that the fields and sectors of busi- be borne in mind that the fields and sectors of business closely connected with those of the Company are ness closely connected with those of the Company are those stated in the Company’s purpose, with particu- those stated in the Company’s purpose, with particular reference to companies or corporations operating lar reference to companies or corporations operating in the financial, industrial, banking, insurance and in the financial, industrial, banking, insurance and real real estate sectors and in the services field in general. estate sectors and in the services field in general. 16.2 The ordinary shareholders’ meeting shall elect the 16.2 The ordinary shareholders’ meeting shall elect the Board of Statutory Auditors and determine its re- Board of Statutory Auditors and determine its remuneration. The minority shareholders shall be en- muneration. The minority shareholders shall be titled to appoint one standing auditor and one alter- entitled to appoint one standing auditor and one nate auditor. alternate auditor. 16.3 The Board of Statutory Auditors shall be appoint- 16.3 The Board of Statutory Auditors shall be appointed ed in compliance with applicable laws and regula- in compliance with applicable laws and regulations tions and with the exception of the provisions of the and with the exception of the provisions of para- third-to-last paragraph of this article 16, on the ba- graph 17 of this article 16, on the basis of slates sis of slates presented by the shareholders in which presented by the shareholders in which candidates candidates are listed by consecutive number. are listed by consecutive number. 16.4 Each slate shall contain a number of candidates 16.4 Each slate shall contain a number of candidates which does not exceed the number of members to which does not exceed the number of members to be appointed. be appointed. 16.5 Shareholders who, alone or together with other 16.5 Shareholders who, alone or together with other shareholders, represent at least 1,5 percent of the shareholders, represent at least 1,5 percent of the shares with voting rights in the ordinary sharehold- shares with voting rights in the ordinary shareholders’ meeting or the minor percentage, according to ers’ meeting or the minor percentage, according to the regulations issued by Commissione Nazionale the regulations issued by Commissione Nazionale per le Società e la Borsa for the submission of slates per le Società e la Borsa for the submission of slates for the appointment of the Board of Directors shall for the appointment of the Board of Directors shall be entitled to submit slates. be entitled to submit slates. 16.6 Each shareholder may present or take part in the 16.6 Each shareholder may present or take part in the presentation of only one slate. presentation of only one slate. 16.7 The slates of candidates, which must be under- 16.7 The slates of candidates, which must be undersigned by the parties submitting them, shall be signed by the parties submitting them, shall be filed filed in the Company’s registered office at least in the Company’s registered office at least twenty twenty five days prior to the date set for the share- five days prior to the date set for the shareholders’ holders’ meeting to be held on first call except for meeting to be held on first or single call that is those cases in which the law and/or the regulation required to decide upon the appointment of provide an extension of the deadline. the members of the Board of Statutory Audi- Without limitation to any further documentation tors, except for those cases in which the law and/ required by applicable rules, including any regula- or the regulation provide an extension of the dead- tory provisions, a personal and professional curric- line. They are made available to the public at ulum, mentioning also the offices held in manage- the registered office, on the Company website ment and supervisory bodies of other companies, and in the other ways specified by Commis- of the individuals standing for election must be sione nazionale per la Società e la Borsa reg- enclosed with the slates together with statements ulations at least 21 days before the date of the in which the individual candidates agree to: general meeting. — their nomination Without limitation to any further documentation re- — attest, under their own liability, that there are quired by applicable rules, including any regulatory no grounds for their ineligibility or incompat- provisions, a personal and professional curriculum ibility, and that they meet the requisites pre- including also the offices held in management and 186 Annual Financial Report at December 31, 2010 Volume 1

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scribed by law, by these By-laws and by regula- supervisory bodies of other companies, of the indi- tion for the position. viduals standing for election must accompany the slates together with the statements in which the individual candidates agree to: — their nomination — declare, under their own liability, that there are no grounds for their ineligibility or incompatibility, and that they meet the requisites prescribed by law, by these By-laws and by regulation for the position. Any changes that occur up to the date of the Shareholders’ Any changes that occur up to the date of the Share- meeting must be promptly notified to the Company. holders’ meeting must be promptly notified to the Company. 16.8 Any slates submitted without complying with the 16.8 Any slates submitted without complying with the foregoing provisions shall be disregarded. foregoing provisions shall be disregarded. 16.9 Each candidate may appear on only one slate, on 16.9 Each candidate may appear on only one slate, on pain of ineligibility. pain of ineligibility. 16.10 The slates shall be divided into two sections: one for 16.10 The slates shall be divided into two sections: one for candidates for the position of standing Auditor and candidates for the position of standing Auditor and one for candidates for the position of alternate Au- one for candidates for the position of alternate Au- ditor. The first candidate listed in each section must ditor. The first candidate listed in each section must be selected from among the persons enrolled in the be selected from among the persons enrolled in the Register of Auditors who have worked on statutory Register of Auditors who have worked on statutory audits for a period of no less than three years. audits for a period of no less than three years. 16.11 Each person entitled to vote may vote for only one 16.11 Each person entitled to vote may vote for only one slate. slate. 16.12 The Board of Statutory Auditors shall be elected as 16.12 The Board of Statutory Auditors shall be elected as specified below: specified below: a) two standing members and one alternate mem- a) two standing members and one alternate member shall be chosen from the slate which obtains ber shall be chosen from the slate which obtains the highest number of votes (known as the ma- the highest number of votes (known as the majority slate), in the consecutive order in which jority slate), in the consecutive order in which they are listed thereon; they are listed thereon; b) the remaining standing member and the other b) the remaining standing member and the other alternate member shall be chosen from the slate alternate member shall be chosen from the slate which obtains the highest number of votes cast which obtains the highest number of votes cast by the shareholders after the first slate (known by the shareholders after the first slate (known as the minority slate), in the consecutive order as the minority slate), in the consecutive order in which they are listed thereon; if several slates in which they are listed thereon; if several slates obtain the same number of votes, a new vote be- obtain the same number of votes, a new vote between said slates will be cast by all those entitled tween said slates will be cast by all those entitled to vote attending the meeting, and the candidates to vote attending the meeting, and the candidates on the slate which obtains the simple majority of on the slate which obtains the simple majority of the votes will be elected. the votes will be elected. 16.13 The chair of the Board of Statutory Auditors shall 16.13 The chair of the Board of Statutory Auditors shall pertain to the standing member listed as the first pertain to the standing member listed as the first candidate on the minority slate. candidate on the minority slate. 16.14 The position of a standing auditor which falls vacant 16.14 The position of a standing auditor which falls va- due to his/her death, forfeiture or resignation shall cant due to his/her death, forfeiture or resignation be filled by the alternate auditor chosen from the shall be filled by the alternate auditor chosen from same slate as the former. In the event of the replace- the same slate as the former. In the event of the re- ment of the Chairman of the Board of Statutory Au- placement of the Chairman of the Board of Statuto- ditors, the chair shall pertain to the candidate listed ry Auditors, the chair shall pertain to the candidate in the same slate of the former Chairman, following listed in the same slate of the former Chairman, fol- the order contained in the list; if it proves impos- lowing the order contained in the list; if it proves Extraordinary part 187

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sible to effect substitutions and replacements under impossible to effect substitutions and replacements the foregoing procedures, a shareholders’ meeting under the foregoing procedures, a shareholders’ shall be called to complete the Board of Statutory meeting shall be called to complete the Board of Auditors which shall adopt resolutions by relative Statutory Auditors which shall adopt resolutions by majority vote. relative majority vote. 16.15 When the shareholders’ meeting is required, pursu- 16.15 When the shareholders’ meeting is required, pursuant to the provisions of the foregoing paragraph or ant to the provisions of the foregoing paragraph or to the law, to appoint the standing and/or alternate to the law, to appoint the standing and/or alternate members needed to complete the Board of Statu- members needed to complete the Board of Statu- tory Auditors, it shall proceed as follows: if auditors tory Auditors, it shall proceed as follows: if auditors elected from the majority slate have to be replaced, elected from the majority slate have to be replaced, the appointment shall be made by relative majority the appointment shall be made by relative majority vote without slate constraints; if, however, auditors vote without slate constraints; if, however, auditors elected from the minority slate have to be replaced, elected from the minority slate have to be replaced, the shareholders’ meeting shall replace them by rel- the shareholders’ meeting shall replace them by relative majority vote, selecting them where possible ative majority vote, selecting them where possible from amongst the candidates listed on the slate on from amongst the candidates listed on the slate on which the auditor to be replaced appeared and in which the auditor to be replaced appeared and in any event in accordance with the principle of neces- any event in accordance with the principle of necessary representation of minorities to which this By sary representation of minorities to which this By Laws ensure the right to take part to the appoint- Laws ensure the right to take part to the appointment of the Board of Statutory Auditors. ment of the Board of Statutory Auditors. The principle of necessary representation of minori- The principle of necessary representation of minor- ties shall be considered complied with in the event ities shall be considered complied with in the event of the appointment of Statutory Auditors nominat- of the appointment of Statutory Auditors nominat- ed before in the minority slate or in slates differ- ed before in the minority slate or in slates different other than the one which obtained the highest ent other than the one which obtained the highest number of votes in the context of the appointment number of votes in the context of the appointment of the Board of Statutory Auditors. of the Board of Statutory Auditors. 16.16 In case only one slate has been presented, the share- 16.16 In case only one slate has been presented, the shareholders’ meeting shall vote on it; if the slate obtains holders’ meeting shall vote on it; if the slate obtains the relative majority, the candidates listed in the re- the relative majority of the share capital, the can- spective section shall be appointed to the office of didates listed in the respective section shall be ap- standing auditors and alternate auditors; the can- pointed to the office of standing auditors and alter- didate listed at the first place in the slate shall be nate auditors; the candidate listed at the first place appointed as Chairman of the Board of Statutory in the slate shall be appointed as Chairman of the Auditors. Board of Statutory Auditors. 16.17 When appointing auditors who, for whatsoever 16.17 When appointing auditors who, for whatsoever reason, were not appointed under the procedures reason, were not appointed under the procedures established herein, the shareholders’ meeting shall established herein, the shareholders’ meeting shall vote on the basis of the majorities required by law. vote on the basis of the majorities required by law. 16.18 Outgoing members of the Board of Statutory Audi- 16.18 Outgoing members of the Board of Statutory Audi- tors may be re-elected to office. tors may be re-elected to office. 16.19 Meetings of the Board of Statutory Auditors may, if 16.19 Meetings of the Board of Statutory Auditors may, if the Chairman or whoever acts in his/her stead veri- the Chairman or whoever acts in his/her stead veri- fies the necessity, be attended by means of telecom- fies the necessity, be attended by means of telecommunications systems that permit all attendees to munications systems that permit all attendees to participate in the discussion and obtain information participate in the discussion and obtain information on an equal basis. on an equal basis. 188 Annual Financial Report at December 31, 2010 Volume 1

2. to grant the Board of Directors - and on its behalf, the Prelios S.p.A. shares,” in its restated amount of negative Chairman and Deputy Chairmen of the Company, all € 32,498,345.12, and hence voluntarily reducing share acting separately - all powers necessary to satisfy the capital by an equal amount (the “Reduction”). necessary formalities to enter the decisions taken in the Companies’ Registry, accepting and introducing therein THE REDUCTION PROCEDURE any formal and non-substantial amendments, additions or deletions required by the relevant Authorities”. In terms of implementation, since the company share capital is divided into shares without par value, the Re- As regards the second proposal: duction will not entail writing off company shares but rather a decrease in the implicit value of their accounting Voluntary reduction of the share capital by the parity. The Reduction will not alter the overall amount of amount of € 32,498,345.12 pursuant to article 2445 company equity, since the entire amount of the reduction of the Italian civil code, to be allocated to stockhold- will permit the write-off of the negative reserve designated ers’ equity; consequent amendments to article 5 of “Reserve from the assignment of Prelios S.p.A. shares.” the By-Laws. Inherent and consequent resolutions. In procedural terms, the reduction of share capital cannot be executed, pursuant to Article 2445(3) Italian Civil PREFACE Code, until 90 days have passed from the date the resolution of the extraordinary shareholders’ meeting has been The proposed voluntary reduction of share capital is re- filed with the Companies Register, provided that no cred- lated to the assignment (the “Assignment”) of shares in itor on the books prior to filing has raised opposition dur- Prelios S.p.A. (formerly Pirelli & C. Real Estate S.p.A.) ing that time period. Pursuant to Article 2445(4) Italian by the company in 2010 and represents the natural com- Civil Code, if opposition is presented before that date, the pletion thereof. Court may order that the Reduction may take place any- As you know, the Assignment was carried out by assign- way, if it finds that no harm has been caused to creditors ing to the shareholders of Pirelli & C. S.p.A. almost all or the company has posted adequate security. the Prelios S.p.A. ordinary shares owned by the company On the first Monday of market trading following the ex- and implemented through a reduction of share capital, piration of the time period granted to company creditors the actual amount of which was determined by the share- under Article 2445 Italian Civil Code to oppose the re- holders of Pirelli & C. S.p.A., at their extraordinary meet- duction in share capital, or on any other day agreed with ing of July 15, 2010, to be equivalent to the fair value of the competent authorities, the company will charge the the Prelios equity holding that was assigned (equal to € amount of the capital reduction to the “Reserve from the 178,813,982.89), determined on the basis of the official assignment of Prelios S.p.A. shares,” which at December price of Prelios stock (€ 0.367) on July 14, 2010, the mar- 31, 2010 showed a negative balance equal to the amount ket trading day preceding the date of the meeting. of the reduction. The shareholders of Pirelli & C. will, in The Assignment was made on October 25, 2010, pursu- any case, be informed of the date on which the transac- ant to Article 2445(3) Italian Civil Code, 90 days after tion will be carried out in accordance with current law the resolutions by the Pirelli & C. shareholders at their Regarding the treasury shares in the company portfolio extraordinary meeting of July 15, 2010 had been filed (equal, at the date of this report, to 351,590 ordinary with the Companies Register. shares and 408,342 savings shares), their number will be In compliance with IFRSs, Pirelli & C. S.p.A. restated unaffected by the Reduction, and their new accounting the liability deriving from the Assignment in the com- par value will be identical to that of the other shares out- pany financial statements from € 178,813,982.89 to€ standing. 211,312,328.01, based on the official market price of the Regarding the amendments to the Bylaws necessitated by Prelios S.p.A. stock reported on the aforesaid closing date the reduction of capital, we propose adding a new para- of the Assignment (€ 0.4337), with a balancing entry of € graph to Article 5 that reflects the proposed resolution to 32,498,345.12 to reduce equity, reported under the item reduce share capital, as indicated in this report. “Reserve for the assignment of Prelios S.p.A. shares.” At Please note, lastly, that the amendments to the Bylaws do the same time, Pirelli & C. recorded a loss on the income not constitute grounds for withdrawal. statement of € 118.3 million against the assignment of More specifically, the procedure for executing the Reduc- Prelios shares, corresponding to the difference between tion in no way alters the rights assigned to the savings the value of the liability, as restated above, and the net shares. In fact, the equity privileges associated with those book value of the Prelios S.p.A. shares. shares remain at the fixed value (Euro 3.19). This fixed Thus, in order to adjust the book value of the share value will therefore be unaffected by the change in the ac- capital of Pirelli & C. S.p.A. to equity, it is advisable counting par value of the company shares resulting from to cancel the entire “Reserve from the assignment of the reduction in company share capital. Extraordinary part 189

Therefore, the resolution to reduce share capital and the ACCOUNTING AND TAX EFFECTS OF THE related amendments to the Bylaws need not be submit- REDUCTION ted for approval by an extraordinary meeting of savings shareholders pursuant to Article 146(1)(b) of Legislative The table below shows the pro-forma accounting com- Decree 58 of February 24, 1998, since they in no way position of the equity of Pirelli & C. S.p.A. at December prejudice the rights of the category. 31, 2010, including the effects of the proposed reduction of share capital.

Description item Equity at Effects of the proposed Equity at December 31, 2010 December 31, 2010 reduction of share capital on after the proposed reduction equity at December 31, 2010 of share capital (*)

Share capital (**) 1,377,878,879.78 (32,498,345.12) 1,345,380,534.66 Legal reserve 99,906,065.17 - 99,906,065.17 Share premium reserve 229,431,693.83 - 229,431,693.83 Business combinations reserve 22,460,868.47 - 22,460,868.47 Reserve from the assignment of Prelios shares (32,498,345.12) 32,498,345.12 - IAS transition reserve (239,425,665.64) - (239,425,665.64) IAS operational reserve 15,687,342.07 - 15,687,342.07 Retained earnings 25,932,216.81 - 25,932,216.81 Net income for 2010 87,404,078.79 - 87,404,078.79

Total 1,586,777,134.16 - 1,586,777,134.16

(*) The data in the table do not reflect the resolutions submitted for shareholder approval at the general meeting, i.e. (i) the proposal for allocation of the net income reported on the 2010 company financial statements and (ii) the proposal to cover the IAS transition reserve through total utilisation of the share premium reserve and the difference by partial use of the business combinations reserve). (**) Includes the treasury shares held by the company, equal at the date of this report to 351,590 ordinary shares and 408,342 savings shares. 190 Annual Financial Report at December 31, 2010 Volume 1

From the tax standpoint, the reduction of capital in the RESOLVES proposed terms will have no effect on profit and loss. 1. to reduce the share capital, pursuant to Article 2445 PROPOSED RESOLUTIONS Italian Civil Code, by an amount of € 32,498,345.12, i.e. from € 1,377,878,879.78 to € 1,345,380,534.66, Based on the foregoing, the Board of Directors submits without cancelling the shares, and to establish that the following proposed resolutions for your approval: the entire amount of the reduction be allocated to reserves and be utilised specifically to cancel the “The extraordinary meeting of the shareholders of Pirelli negative equity reserve designated “Reserve from the & C. S.p.A.: assignment of Prelios S.p.A. shares”; 2. to take note that, pursuant to Article 2445(3) Ital- — having examined the explanatory report of the Board ian Civil Code, the resolution to reduce share capital of Directors; may not be executed by the Board of Directors until ninety days have passed after its filing with the Com- — having taken note that the general shareholders’ meeting panies Register, without prejudice to the provisions has resolved to approve the 2010 financial statements and of Article 2445(4) Italian Civil Code; that those financial statements include a negative reserve 3. consequently, to amend Article 5 of the company in the total amount of € 32,498,345.12 under the item By-Laws, by adding a final paragraph as indicated “Reserve from the assignment of Prelios S.p.A. shares”; below:

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Article 5 Article 5

5.1 The Company shall have a subscribed and paid-in 5.1 The Company shall have a subscribed and paid-in share capital of EUR 1,377,878,879.78 (onebil- share capital of EUR 1,377,878,879.78 (onebil- lionthreehundredandseventysevenmillioneight- lionthreehundredandseventysevenmillioneight- hundredandseventyeightthousandeighthundred- hundredandseventyeightthousandeighthundred- seventyninepointseventyeight) divided into no. seventyninepointseventyeight) divided into no. 487,991,493 (fourhundredeightysevenmillion- 487,991,493 (fourhundredeightysevenmillion- ninehundredninetyonethousandfourhundredni- ninehundredninetyonethousandfourhundredni- netythree) shares without par value consisting of netythree) shares without par value consisting of 475,740,182 (fourhundredseventyfivemillionsev- 475,740,182 (fourhundredseventyfivemillionsev- enhundredfortythousandonehundredeighty) ordi- enhundredfortythousandonehundredeighty) ordinary shares and 12,251,311 (twelvemilliontwohun- nary shares and 12,251,311 (twelvemilliontwohun- dredfiftyonethousandthreehundred-eleven) savings dredfiftyonethousandthreehundred-eleven) savings shares. shares. 5.2 In resolutions to increase the share capital by issu- 5.2 In resolutions to increase the share capital by issuing shares against payment, pre- emption right may ing shares against payment, pre- emption right may be excluded for up to a maximum of ten percent be excluded for up to a maximum of ten percent of the previously existing capital, provided that the of the previously existing capital, provided that the issue price corresponds to the market value of the issue price corresponds to the market value of the shares and that this is confirmed in a specific - re shares and that this is confirmed in a specific - re port prepared by the firm appointed to audit the port prepared by the firm appointed to audit the accounts. accounts. 5.3 If so resolved by the shareholders’ meeting, the 5.3 If so resolved by the shareholders’ meeting, the share capital may also be increased by means of share capital may also be increased by means of contributions in kind or of receivables. contributions in kind or of receivables. 5.4 If resolved by the Shareholders’ Meeting, the share 5.4 If resolved by the Shareholders’ Meeting, the share capital may be reduced also by assignment of non- capital may be reduced also by assignment of non- cash assets to the shareholders. cash assets to the shareholders. 5.5 Pursuant to the resolution adopted by the extraordinary shareholders’ meeting held April [•], 2011, the share capital has been voluntarily reduced from Euro 1,377,878,879.78 Extraordinary part 191

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to Euro 1,345,380,534.66, to be accomplished by allocating the entire amount of the reduction to equity. This reduction shall be carried out in accordance with Article 2445(3) Italian Civil Code.

(*) Text resulting from approval of the proposed resolutions as set forth in the first point of the agenda of the extraordinary general meeting

4. to grant to the Board of Directors – and on its behalf the Chairman and Deputy Chairmen, separately – full authority and all rights necessary to implement the foregoing resolutions, to fulfil any act and/or formal- ity necessary to have them filed with the Companies Register, accepting and effecting any formal and non- substantive, changes, additions or deletions requested by the competent authorities, to agree with the competent authorities on the terms, conditions and procedure for executing the reduction of share capital, and to adjust the numerical amounts specified in Article 5 of the Bylaws once the resolved reduction of capital has been accomplished.”

The Board of Directors

Milan, March 8, 2011